I am opening this thread to post some important Articles on Psychology of Trading. I request you all to share more informative articles on this thread. Psychology plays an important role in our day to day activities and in the case of Trading, its much more evident. To succeed in Trading, the Trader should be psychologically and emotionally very strong and the more we understand about it the more better it is. To begin with, I am sharing a nice article on Psychology of Trading with you all, please keep this thread populated with many more articles.
The psychological state of the crowd and the psychological state of the investor or trader are important areas to look at when considering an investment or trade. Bubbles and crashes within any market arise out of crowd psychology. Bubbles and crashes in any one individual account also arise out of the psychological state the single person brings to both their decision and their execution of their decision.
What do we mean by psychological state? Answer: The combination and type of intellectual, physical and emotional energy coming to bear upon an investment or trading decision. Put another way - trading psychology is the sum total influence of a human psyche on the process of making an investment or trading decision. The American Heritage dictionary defines psyche as: "The mind functioning as the center of thought, emotion, and behavior and consciously or unconsciously adjusting or mediating the body's responses to the social and physical environment."
Fear and Greed
Typically when people talk about psychology in the markets they reduce it to the emotions of fear and greed. Likewise, the typical response is to try to avoid the influence of the feelings of fear or greed. In many ways, this is a futile effort in that those emotional responses are natural and are not going to go away. A better approach is to accept that reality and learn how to become aware of their influence on a decision and also aware of their influence on how a stock might be acting.
Emotional Awareness in Investing
In actuality, the situation is much more complex and nuanced than that and the work being done in trading psychology now is extending and applying the work of neuroscience in understanding the human response to a risk reward decision. Researchers such as Dr. Andrew Lo of MIT, Dr. Brian Knutson of Stanford and Camelia Kuhnen of Northwestern are delivering excellent work which illuminates just exactly what the brain is doing when faced with a choice about risk.
There is great evidence for the value of actually including emotional intelligence in making decisions about the financial markets. This is an area that is just beginning to be explored. It also extends to the interaction between human and computer in the situation where trading strategies are driven by quantitative models which drive automatic trade executions in the market.
How Can an Investor Account for Psychology?
Two simple ways to address this ever-present issue are to always ask the following two questions. #1)Is my analysis being impacted by what the crowd is doing? #2) Is my analysis being colored by the result of my last investment or trade? Including an analysis of the the human factors influencing a trading decision offers to opportunity to reduce risk and improve return.