Fighting fear and greed in the financial market
Trading in the stock market is based on the interaction of three components: analysis, money management and the psychology of trading. The emotional component can both positively affect and lead to a complete collapse. Emotions – invisible participants in our lives – let people down despite their knowledge and experience. For the most part, live people participate in the auction, which base their actions on practically the same economic indicators and price graphs. However, some earn on it, while others lose.
It is emotions that distort our perception of what is happening and force us to perform actions that lead to the loss of capital brought to the market. It is possible to earn a lot and correctly on a virtual account, but, without curbing your emotions, it is impossible to correctly apply the knowledge and experience gained.
Most often, the “properties of the soul” of a person manifest themselves in financial markets not from the best side. Many books on market psychology have been written on this topic. Why most often we make the wrong and unprofitable financial decisions? Why are we so easily deceived and we are happy to be deceived ourselves?
It turned out that there are not so many mistakes that people make when working on the stock market. For example, one of the founders of psychological economics and behavioral finance, Daniel Kahneman, draws attention to only 5 main ones.
numbering-small.pngThe five reasons for the failure of an investor for Kahneman
1. Self-confidence. Every investor, regardless of whether he controls his own or other people’s money, is convinced: he knows something that others do not know. On this basis, they often perform operations without considering their risk.
2. Myopia. People often focus only on short-term gains or losses, and do not think at all about their financial situation for the future, at least in a few years.
3. Excessive optimism. Kahneman conducted an experiment: asked the students how great their chances of getting cancer or becoming alcoholics were. The vast majority of respondents found their chances very low. Although in fact the probability for each of them is the same. Another example. If you ask the owners of companies, what are their chances of success, two-thirds will estimate their at least 70%. And 25% of businessmen generally believe that they reach 100%. In reality, 65% of new companies go bankrupt in the first 5 years.
4. Separation of accounts. Investors perceive all their accounts separately, instead of treating them as whole, combined capital.
5. Buying bad assets and selling good ones. Any property — stocks, apartments, bank deposits, and other income-generating assets — is an asset. An experiment conducted by scientists showed that stocks that are sold by investors for one year show a yield of 3.4% higher than stocks that investors buy.
All novice investors, in order to start successful work in the stock market, need to restructure their attitude to their investments. It is necessary to understand that stock or bond quotes can both grow and fall – it is important to calmly assume that at some point in time, the value of assets in an investor’s portfolio can generate income, and at some point a loss.
It is precisely at the moments of rising or falling prices that an investor should muster the will into a fist and not succumb to random emotional impulses leading to hasty deals in the market.
From the point of view of psychology, three components have a decisive influence on the behavior of people in the financial market: fear, greed, and hope. A large number of players take part in the trading process, whose opinions on this or that event cannot be learned and evaluated.
When the majority of bidders perceive the information quite clearly and begin to perform certain actions based on it, the market begins to submit to the aggregate opinion of the crowd. And this opinion becomes the factor that allows prices to move. Therefore, in the stock market trading, it is imperative to take into account the opinion and mood of other participants and move in a general trend, not take risks, trying to go in the opposite direction.
Tips for novice traders
1. Do not give in to emotions and do not engage in self-deception. It should always be remembered that spontaneous, reckless transactions that an investor makes in the hope of making a small profit, often turn into big losses.
2. Cheer up with losses. No investor escaped losses in the stock market, even a professional one. Do not fall into despair when closing unprofitable positions. Try to analyze the mistakes made, make the appropriate conclusions to avoid them in the future.
3. Do not rush to enter into transactions, the market will not run away. Unlike the fixed-income securities market, where there is a final maturity date of the paper at its nominal value, the stock market does not have any clear guidelines for the final price growth of a particular stock. Therefore, it is better to enter the market a week (a month) later and buy stocks at a lower price than to make a deal when the market is already very overheated.