The stock market can get the better of our emotions and for this reason it is important to improve one’s psychology to increase trading performance. In this study we will look at the emotions and biases that influence our investment decisions.
Investing is an activity strongly driven by emotions. For example, when cryptocurrencies became a mainstream asset, dozens of investors from novice to experienced flocked to the market out of fear of “missing the train,” a concept described in social psychology as the bandwagon effect.
For years, emotions such as fear, happiness, anger and greed have been showing up on the market and emotions can both positively and negatively affect an investor’s decision-making process, thus determining the success or failure of the investment itself.
In this regard, the analysts of BG Saxo observe that the capacity for self-awareness it is one of the best ways to counter emotions or behaviors that negatively affect the ability to make good investment decisions.
What is trading psychology and why is it important?
Trading psychology refers to the emotional and mental state of an investor while making investments in the stock market, but it also refers to the emotional state of the investor when entering and exiting a trading platform. While every investor is different, emotions are the same for everyone and those associated with trading psychology include greed, fear and regret. But not only that, positive emotions such as trust and pride can also affect the investor when he makes a big profit or suffers a heavy loss.
For example, thegreed it can distract your rationality, and this desire for wealth can trigger irrational investments, in which, for example, you make high-risk trades or buy stocks without first conducting proper fundamental and technical analysis. In this sense thefundamental analysis means looking at balance sheet data and the economy as a whole to assess the value of a stock, while thetechnical analysis uses various indicators and tools to identify the trend of a market (trend) and build different hypothetical scenarios on its evolution, thus looking at the movements in price and volume.
Similarly, the fear it’s an irresistible emotion that can get you out of the markets too soon. Investors can also refrain from taking risks due to loss problems. Fear can sometimes turn into panic, which causes a stock’s price to drop without reasoned analysis.
Even positive emotions like the confidence they can have negative implications when it is not balanced and reaches extreme levels. For example, one concept in behavioral finance is self-attribution. It refers to an investor’s tendency to make decisions based on overconfidence in themselves and their abilities. Excessive confidence, not only in oneself but also in a particular market can lead to heavy losses if investors wait too long, thinking the market will return to growth.
Investment distortions
It’s not just your emotions that can affect your investing business, but the innate biases you may not realize you have. THE prejudices (bias) can affect investments as they are often predetermined and can also result in investors acting on a gut feeling rather than conducting a rational analysis. There are many cognitive biases that if noticed can be overcome quickly and efficiently. Some examples are: player error, confirmation bias, representative bias, and status quo bias.
The Gambler’s Mistake
Gambler’s mistake is a bias that an individual believes that the likelihood of something happening increases or decreases if an event or process is repeated. Let’s say an investor continues to increase his or her position in a stock despite the fact that he has witnessed repeated and increasing losses if the investor believes that the stock price will most likely change direction as the losses continue to rise. But this mentality is incorrect as each event is independent and there is no correlation between past and present events.
Confirmation bias
Another common cognitive bias is confirmatory, which is where you seek, believe or favor information that supports / confirms your pre-formulated beliefs. Investors can also intentionally ignore information that contradicts these values and beliefs. For example, if you are bent on acquiring stock in a company, such as Tesla, Amazon, or Alphabet, you may be ignoring the unfavorable news on that particular company’s quarterly reports, and by doing so you are committing a form of confirmation bias.
Representative bias
If you are repeating investments because they have previously led to success, this is an example of representative bias. Another example is if you believe an investment is good or bad based on a company’s past performance. Suppose a company you invested in releases a strong earnings report, then you assume the next earnings report will be just as good, but as you now know through gambler’s mistake, past events don’t change the probability. certain events occur in the future.
The future is unpredictable by definition!
I am biased against the status quo
Like the representative bias, the status quo bias means that you are making old investments or using old strategies rather than exploring new options. If you use old methods to make new investments, you may be blinded by your perceptions and fail to recognize that the market has changed and your old strategies are not viable.