Archives of “irrational decisions” tag

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How does the mind of a trader work?

  
  Education
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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. (more…)

Greed, Fear and Irrational Behaviour

  
  Education
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Where trading and investing in stocks, options, futures, forex, etc are concerned, there is no doubt that people have a tendency to behave strangely. Exhibiting irrational behaviour is common. People come up with all sorts of reasons and excuses for the way they are behaving, even while subconsciously admitting that they are deviating from their plan without valid reason.

The field of Behavioural Finance attempts to interpret and understand why people behave the way they do with financial activities. It is an investigation of how people’s decisions are affected by cognitive errors and emotions. 

Some key points in Behavioural Finance are:

  • The ‘Fear of Regret’ – where people beat themselves up about incorrect decisions or errors of judgement. They avoid this pain by holding onto positions that are moving against them, despite the intelligence that they should exit the trade while the loss is small.
  • People are more upset by potential losses than pleased by wins.
  • People perceive chance wins as trading success.
  • The more people win, whether by method or luck, the more confident they become. This is very dangerous for those who win by luck.
  • People are more exuberant and optimistic on bullish days and depressed and pessimistic on bearish days.
  • People tend to make irrational decisions reflecting biased or wrong beliefs. People have a tendency to cling to beliefs, even when presented with evidence to the contrary. (more…)
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