There’s often little logic in the movements of the market.
This is because stocks move at the whim of human beings, who are often illogical themselves and driven by emotions. With as many technical and fundamental analyses done on equities, one their most important influences is psychology. Realizing this can help you learn how to invest better.
Psychology is a vital, but under-appreciated element of stock trading. This is because most analysts are more mathematically focused. But those who ignore the human and social aspect of the market are making a serious mistake.
There are four different emotions which cause most investor’s decisions. They are greed, fear, hope, and regret.
Greed is the desire for money and wealth. When a trader experiences greed, they are only able to think about how much money they have made from a stock and how much more they can make by keeping their position.
The problem? Profit is not realized until after a position is closed. Until this happens, a trader only has the potential for profit. Greed can lead to an investor holding a stock for longer than they should, hoping to make more money… until it plummets.
Fear, which is probably the strongest of all human emotions, causes a trader to sell a position regardless of its price. Unlike other emotions, fear is a survival response. The Dow Jones Industrial Average (DJIA) in the U.S. took from 1983 until 2007 (24 years) to grow from 1,000 to 14,200, but it only took two years to lose 50% of its value (2007-2009). That’s the power of fear.
Fear can be beneficial if it gets you out of a poor trade. But it’s dangerous when causing investors to not buy a stock which would otherwise be profitable.
Hope, a feeling of expectation and desire, might be the second most dangerous emotion. It’s what keeps a trader in an unprofitable position.
When a losing stock decides to go up, investors will often stay in the “hope” of recouping past losses. This is dangerous because the market will do what it does, regardless of an investor’s wishes.
Regret is a feeling of disappointment over something which happened. It can cause a loss of focus.
It’s natural to regret making a bad trade or missing a good one. But an investor must simply learn from what went wrong and move to the next opportunity. This is the only way to ever learn how to invest better.
The cycle of investor psychology.
Market psychology can be a very powerful tool. Traders usually just wonder if they should buy or sell a stock. Instead, you should ask yourself “what are others doing?”.
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