If you take a look at the video you can see I look a little different – I’m talking about my hair. Today I’m going to talk about how to have a bad hair day every single day! Kidding. I don’t know about you guys but I really need to get a haircut or else i’ll go crazy. In all seriousness, I’m going to talk about how to understand the psychology of the markets. I will look into how it continues to go up, even though there’s so much bad news happening?
The Ego & the Emotional Drive
We first need to understand human behavior and psychology. This is what drives the markets. Humans are very emotionally driven. We have big egos. As a result we think we are always correct. Human behavior is amplified when you throw the stock markets into it. This explains why many new traders blow up their account even though they know they should have a stop loss and risk management in place. They are in denial and continue to move their stop loss. They enter a trade with no risk management in the first place. The only reason to do this is if they think there is no way they could be wrong.
Humans tend to jump the gun before fully rationalizing and weighing the pros and cons of a scenario. This is a product of being emotionally driven. This is why many amateurs, over the past month, try and “predict the bottom” or catch a falling knife. They did this even though there were no signs of any rebound yet.
Many amateur traders tried to short the markets as the markets were rebounding. They thought the markets would go lower, but the markets have actually been going up. I struggled with most when I first started trading. It is always important to have this on the top of the mind because there is so much volatility and fluctuation in the markets.
Be Patient & Open-minded
Another aspect of human psychology, that ties into the markets, is a lack of patience. I’m not talking about the patience to wait for your significant other to get ready… that is true patience! Instead of waiting for confirmation like we should, we jump the gun. As much as I want to short this market currently, I know I have to be patient. I have to wait for confirmation. I also have to explore the other side of opinions to reduce any personal bias. The practice of looking at both perspectives also improves my overall decision making.
Next is something called confirmation bias. As humans, the moment we believe something is true, we find ways to convince ourselves it’s true. When we believe the markets are going to go down, we read more news on why the markets are likely to go down. Oftentimes ignoring any articles that talk about why it would go up.
In addition, humans are generally just bad decision makers. People were not prepared for Covid-19. I knew a few people who took initiative and did research when the news came out. They prepared for quarantine by buying food, gym equipment, cleaning supplies and more. Once coronavirus was mainstream knowledge, the gym equipment was all sold out or selling at outrageous prices. Now things are taking 4 weeks to deliver! However, the one thing I didn’t understand was the whole toilet paper shortage… Why were people aggressively buying toilet paper? Maybe people were cooking more at home, as a result eating healthier, and needing to use the bathroom more? Who knows.
Think back to a time when you were on the way to a meeting with someone. We naturally default to telling people a time to meet, and then show up 30-min late. We think a project will only take a week to complete but it ends up taking a month. This is the planning fallacy. This means that people tend to be over optimistic and overrate their own abilities. That is why you see so many amateurs jumping into the markets with no experience or background at all, and they throw $10,000 in one stock.
Looking Long Term
The final core component of understanding stock market psychology is taking the longer term point of view. As humans, we’re very bad at planning things in advance. Most people don’t even know what they’re going to eat! I’ve seen so many couples spend hours arguing over a place to eat! It’s absurd, but everyone does it. If we are naturally bad at planning then we are naturally struggling to think long-term. This applies to the stock market! Potentially the markets are going up currently because people haven’t priced in the effects of coronavirus? If history is any indicator of the future, humans are slow to see these things.
Humans are the ones that drive the prices in the stock market. Price is a constant tug of war between people who are bullish and bearish. If you’re able to understand all of the human psychological factors at play, and then overcome them, you increase the chance of your success in the markets.
In summary the core psychological areas that affect humans when it comes to the market are controlling the ego, being less emotionally driven, being more patient, looking at both sides of the argument and looking ahead.
If you can apply this knowledge, you will have a much better understanding of the markets, and you will probably perform better.
Right now – with the markets holding up, I have a feeling that it’s not going to drop until we least expect it. People expect it to drop, and the real fear has not set in yet. It could stay at the current level past earnings season. March happened so quickly – this explains why people have not priced in fear.
As always, if you enjoyed this post then please comment and let me know! Stay tuned for more articles coming up. Stay safe everyone!