As previously discussed, in the thought and behavior of market participants that ultimately determine price action, fear and greed are constantly at work, creating a volatile environment where extremes of emotions is the norm.
In discussing this I focused on how crowd behavior effects price action, and how we can try to use technical indicators to measure these extremes.
However, it is important to also recognise the very real and powerful effects that mass psychology and crowd behavior has on us, the individual trader.
The market is literally a melting pot, where all of the thoughts, emotions, opinions, biases, and expectations of many thousands of individuals come together in a chaotic, frantic manner. This volatile setting where so many conflicting ideas and emotions converge creates a situation that can be very overwhelming to both the novice and experienced trader alike.
What happens is that when we take a trade, we are literally taking a bet. We are betting on ourselves. The money that we risk in a trade has a lot of emotional and mental baggage, that can create a drag on our conciousness and alter our perceptions of the market. It can greatly affect our abilities to make rational decisions based on sound logic and common sense.
Each person is unique, and will have different behavior patterns to deal with. But often there is a lot of fear involved in the new trader with limited experience. There is, of course, the fear of losing and failure… a powerful force that lies very dormant within the psyche. This fear is sometimes very subtle… not easily percieved. Sometimes it is very powerful, causing extreme anxiety, doubt, second-guessing, etc.
Then there are those who have an issue with their self image, self worth, and so forth. Everytime they take a trade, their self esteem is on the line. Just a few losing trades can be very discouraging, causing anxiety, depression, confusion and doubt.
These feelings, which can be acute, have to be recognized and dealt with. Taking the time to do your research, find a methodology, develop a clearly defined plan, backtest it, and papertrade it can really help in toning down these negative feelings. Without a clearly defined trading plan and method we become very prone and suseptible to our fears. Every twist of the market that goes against you can create doubt and confusion… causing premature entries, exits, or worse, hanging on to a losing trade.
By having a clearly defined plan it becomes a matter of exercising discipline. The mind is a funny little machine. Often, the best way to overcome a bad thought or activity, is by giving it an alternative thought or activity. By remaining absolutely focused and dedicated to a trading plan – a trading plan you have gained confidence in through thorough research and papertrading – you can more easily overcome impulsive decisions. This is why EVERY ASPECT of your trading plan needs to be clearly defined. Identifying trades, entry and exits.
Every trade should be planned… and that plan should be traded. Experienced traders that have transcended the effects of crowd behavior can modify their trades and such. But until one has overcome their fear and insecurity, they should stick to their plan! It is all too easy to be influenced by the news, other traders, or the price chart itself when we are in doubt and lack of confident.
Sticking to the plan, exercising discipline and consistency are ways to fight against doubt. Ignore what other traders are thinking. Trade the plan.
For continuation, see part seven of this rather long original article.