Rethinking Trading Psychology: A Functional Definition
Trading psychology is often misunderstood or overly simplified in trading discourse. Psychology, by definition, is the scientific study of the mind and behavior. When applied to trading, trading psychology should be defined as the study of how our mental processes directly influence market structure through behavior—specifically through the act of placing trades.
The Facts: How Humans Influence the Market
Traders interact with the market in only a few meaningful ways:
Placing entries
Setting stop losses
Setting take-profit (target) levels
Though external variables such as news events can impact decision-making, they only affect where we choose to interact with the market—they do not directly move price. Price only responds to order flow, and all order flow originates from trader decisions. Therefore, these three actions—entries, stops, and targets—are the only real mechanisms through which psychology influences price action.
Entry: The Initiator of Market Movement
Entries are typically based on structural cues like engulfing candles or order blocks—price zones where a shift in momentum is visible. These areas act as high-probability triggers that prompt traders to take action in a particular direction.
When enough buy orders are placed at a bullish signal, we see that reflected in the strength and size of bullish candles. Conversely, strong bearish signals generate concentrated sell-side pressure. This collective order flow initiates price movement—entries are the impulse drivers of the market.
Stop Losses: The Creation of Liquidity Pools
Once a position is opened, traders generally place stop losses behind significant structure—often just beyond the order block or engulfing pattern that prompted the entry. These zones become liquidity pools—clusters of pending orders that, when triggered, cause mass exits and reallocation of capital.
When price returns to these zones, it forces traders out of the market, often resulting in sharp movements or false breakouts. This behavior is not coincidental; it is a byproduct of shared psychological behavior manifesting as clustered risk management.
Take-Profits: Delayed Exit Pressure
Alongside stop losses, traders also define target levels where they plan to close their trades. These levels can be calculated based on fixed R-multiples (2R, 3R, etc.) or drawn from contextual zones like previous highs/lows or supply and demand areas.
As price moves into profit and hits these levels, traders begin to exit en masse. This diminishes order flow in the direction of the trade, often leading to hesitation or minor reversals—much like stop losses do when they are hit.
Conclusion: Market Movement vs. Market Stalling
To summarize:
Entries drive market movement
Stop losses and target levels stall or reverse movement
This dynamic defines how human behavior—guided by psychological patterns—actually shapes price. In this framework, engulfments represent entry logic, while liquidity zones represent collective exit logic.
Redefining Trading Psychology
Contrary to popular belief, trading psychology isn’t just about “staying disciplined” or “keeping emotions in check.” While emotional control matters, it’s secondary to understanding how trader behavior creates cause-and-effect loops in price action.
Having a trading plan is important—but deviating from that plan is not always due to emotion alone. It can stem from overconfidence, impulsivity, cognitive bias, or poor conditioning. These are psychological behaviors that affect execution, and thus, affect market movement.
What’s Next
In my next writing, I will explore how the sheer volume of market participants leads to herding behavior—the collective patterns that emerge from mass psychology and their role in creating consolidation zones, liquidity traps, and false breakouts.
Trading psychology is often misunderstood or overly simplified in trading discourse. Psychology, by definition, is the scientific study of the mind and behavior. When applied to trading, trading psychology should be defined as the study of how our mental processes directly influence market structure through behavior—specifically through the act of placing trades.
The Facts: How Humans Influence the Market
Traders interact with the market in only a few meaningful ways:
Placing entries
Setting stop losses
Setting take-profit (target) levels
Though external variables such as news events can impact decision-making, they only affect where we choose to interact with the market—they do not directly move price. Price only responds to order flow, and all order flow originates from trader decisions. Therefore, these three actions—entries, stops, and targets—are the only real mechanisms through which psychology influences price action.
Entry: The Initiator of Market Movement
Entries are typically based on structural cues like engulfing candles or order blocks—price zones where a shift in momentum is visible. These areas act as high-probability triggers that prompt traders to take action in a particular direction.
When enough buy orders are placed at a bullish signal, we see that reflected in the strength and size of bullish candles. Conversely, strong bearish signals generate concentrated sell-side pressure. This collective order flow initiates price movement—entries are the impulse drivers of the market.
Stop Losses: The Creation of Liquidity Pools
Once a position is opened, traders generally place stop losses behind significant structure—often just beyond the order block or engulfing pattern that prompted the entry. These zones become liquidity pools—clusters of pending orders that, when triggered, cause mass exits and reallocation of capital.
When price returns to these zones, it forces traders out of the market, often resulting in sharp movements or false breakouts. This behavior is not coincidental; it is a byproduct of shared psychological behavior manifesting as clustered risk management.
Take-Profits: Delayed Exit Pressure
Alongside stop losses, traders also define target levels where they plan to close their trades. These levels can be calculated based on fixed R-multiples (2R, 3R, etc.) or drawn from contextual zones like previous highs/lows or supply and demand areas.
As price moves into profit and hits these levels, traders begin to exit en masse. This diminishes order flow in the direction of the trade, often leading to hesitation or minor reversals—much like stop losses do when they are hit.
Conclusion: Market Movement vs. Market Stalling
To summarize:
Entries drive market movement
Stop losses and target levels stall or reverse movement
This dynamic defines how human behavior—guided by psychological patterns—actually shapes price. In this framework, engulfments represent entry logic, while liquidity zones represent collective exit logic.
Redefining Trading Psychology
Contrary to popular belief, trading psychology isn’t just about “staying disciplined” or “keeping emotions in check.” While emotional control matters, it’s secondary to understanding how trader behavior creates cause-and-effect loops in price action.
Having a trading plan is important—but deviating from that plan is not always due to emotion alone. It can stem from overconfidence, impulsivity, cognitive bias, or poor conditioning. These are psychological behaviors that affect execution, and thus, affect market movement.
What’s Next
In my next writing, I will explore how the sheer volume of market participants leads to herding behavior—the collective patterns that emerge from mass psychology and their role in creating consolidation zones, liquidity traps, and false breakouts.
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.
Disclaimer
The information and publications are not meant to be, and do not constitute, financial, investment, trading, or other types of advice or recommendations supplied or endorsed by TradingView. Read more in the Terms of Use.