What is Stock Psychology? Table of Contents
The key to understanding finance is in you: know yourself and dominate the markets!
What is stock psychology?
Recently, alongside the old and reliable schools of technical and fundamental analysis, a third trend has emerged that is based on the analysis of large amounts of data (“big data”) and on artificial intelligence to measure market sentiment.
To do this, it conducts global searches in the media and on social networks to find keywords that indicate what the general feeling is about a certain asset.
And, if the market has feelings, it must also be the subject of psychological study.
Stock psychology analyzes two different elements: the operator and the market.
Since the market is an amorphous entity that is made up of many traders (including yourself), it is clear that the behavior of financial markets is subject to instincts, learned behaviors, and thoughts of the people who comprise it, since the assets have no soul (although some preachers of the “new age” claim otherwise).
The most important elements of stock psychology are the instincts of fear and greed, which drive our actions and market behavior, along with the emotions of optimism and pessimism, which often dictate our reactions and provide markets with their cyclical nature.
Stock psychology is not intended to be a clinical experiment.
Its objective is to help us recognize our emotions and instincts as soon as they appear.
In addition to learning to control them on certain occasions, the most important thing is knowing how to extrapolate them.
In the end, It is very likely that other operators will react in the same way as us to a certain situation.
The sooner we understand our own reaction, the sooner we can predict the next market move and monetize it.
Understand the Behavioural Finance
Behavioral finance, or rather behavioral economics, as it is often called, is the study of the impact that the cognitive, emotional, cultural, and social behavior of individuals and institutions has on classical economics.
Since this relatively new field was created, three Nobel Prizes in economics have been awarded to its pioneers: Daniel Kahneman in 2002, Robert Shiller in 2013, and Richard Thaller in 2017, underscoring its importance.
This does not mean that this topic was something new; in fact, Adam Smith and Jeremy Bentham had already made reference to the psychology and even the morality of economics.
In the mid-1970s, Herbert Simon put forward the idea that rationality is limited by the flexibility of a problem, as well as cognitive and other imitations; that is, to fix a problem, people often take harmful shortcuts.
Several years later, Kahneman, along with Amos Tversky, used cognitive psychology to explain the divergence between economic decision-making and the requirements of classical theory.
In summary, on the one hand, we have a classical theory that explains in a utilitarian and mathematical way how things should happen, like the very convenient set of Charles Dow rules (efficient markets), and on the other hand, we have a very human approach that explains by what does not happen like that (real markets).
They used cognitive psychology to explain the divergence between economic decision-making and the requirements of classical theory.
Control fears and plan well from today
As we have indicated before, a secondary objective of stock market psychology is to learn to prevent our emotions from influencing us when it comes to trading (this can certainly be very helpful).
However, the most important thing is that it is a tool that allows us to understand how markets operate and react in a much broader sense.
To avoid getting stuck and not opening a position out of fear, or to avoid opening or not closing a position out of greed, you should obtain as much information as possible about the assets you are trading with.
This information will provide you with a sense of control that will act as a counterpoint to your emotions of fear or greed, and also, more importantly, help you to confirm the validity of the strategies in light of the theoretical foundations.
The ability to set objectives and goals, Managing risk through diversification, hedging, and managing your money properly is not just a tool to keep your emotions from taking over.
It is simply a matter of operating with common sense.
In short, emotions cannot be avoided.
They can hardly be controlled, as has been reflected in countless literary works for centuries.
Yet take a step back and examining them can be an invaluable tool, as is a comprehensive understanding of Elliot Wave Theory, having an expert advisor, or having an untraceable insider source.
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Comment by Diletta
March 26, 2024
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