How does the mind of a trader work?

MindpowerIn order to understand behavioral finance and crowd behavior on the capital market, first of all we need to understand the factors that influence the trader mindset. Traders are “misled” by many things. Let us put these factors in two main categories, depending simply on their source, external or internal.

The most important external factor is “everyone else”, the trading crowd, the general opinion. We form an opinion about the others. We believe them to be either smart or stupid, either right or wrong, then choose one of the two main psychological trading strategies: “go along to get along” or be a contrarian. Then we have other external factors like payoffs, scale, psychological and academic background, social structure, external advisory and resources.

Maybe the most misleading and yet powerful internal factor is the trader instinct. “My feeling is “. I am sorry to say, but that feeling of yours is not quantifiable. Intuitions are good but they are not a system. Whom do we trust more than ourselves, our own hunches, past experience and well-learnt lessons? Overconfidence is by far the most common behavioral error and can lead to irrational decisions, dangerous trading and therefore, huge losses. This is the point where trading is a lot like gambling for a significant part of the players.