Psychology Corner

Psychology in the markets

There are two very distinct approaches to psychology in the markets: individual psychology and group psychology.

Interestingly enough, the behaviour of crowds is a paradoxical indicator when applied to the trading world. When most investors are in consensus and are driving the market in a particular direction, one assumes that the consensus will continue and that the best decision is to follow the crowd. History has proven the exact opposite though. The experienced trader profits by doing exactly the opposite of what other ways seems the logical thing to do. But what if the mass hysteria keeps driving prices in a certain direction. Isn’t that what trend trading is all about?

This is where the two oldest human characteristics show their ugly heads again – greed and fear. Fear keeps the masses out of a trend just long enough for the trend to run its course. The fear of loosing money will keep the inexperienced masses from entering a position until the trend has established itself and is clearly visible. Greed then causes the masses to enter the trend once it has run its course, because the established trend now shows what the trader could have made, and the crowd also wants a piece of the pie. Problem is – it's too late! 

Trading contrary to opinion is deadly effective because of the often-misunderstood axiom that much of living is based on the power of paradox. At the surface, many aspects of life and of investing, like the power of consensus trends, appear to be true and straightforward. But as we have seen, the herd is almost always wrong or at least late in jumping on the bandwagon. 

The individual who is able to recognize the inherent paradox in crowd behaviour is best able to capitalize on the inevitability of contradictory opportunities.

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