One thing that has always amazed me in financial markets is the formation of crowds. When I say crowds, I am referring to the majority of traders sharing the same views and expectations. Even more astonishingly is the fact that the majority is usually wrong at major market turning points. Because the majority is usually wrong, a successful trader needs to separate himself/herself from the crowd.
The formation of a crowd is a psychological phenomenon.
Crowds are formed from individuals with a common cause, and in the case of financial markets, individuals looking for profits. As an investor or trader you will always be faced with a conflict two way pull in your decision making process. On the one hand, your own personal approach to making a trading or investment decision may suggest one course of action; on the other hand the allure of the “herd instinct” may be pulling you entirely in the opposite direction. Seasoned professionals some times find themselves caught in a common frenzy at just that time when contrary opinion is truly appropriate.
But why does this happen?
The answer lays in the emotional part that usually gets committed to a trade whenever a new position is opened.
There is a premise that states that emotion and reason are mutually exclusive. An interesting individual investment psychology model frequently unfolds at major market turning points; tops or bottoms.
The model starts with expectations diverging from actual outcomes; meaning a trade starts to turn in to a loss, the individual experiences feelings of anxiety that gradually wind them self up to high levels of fear.
Once anxiety begins to roll forward, it can be self-destructive; it has the potential power to create inappropriate actions. Inappropriate actions then result in unexpected or unwanted results, which, in turn create further anxiety.
Eventually, the anxiety becomes fear. Constant anxiety and fear, result in individuals turning to a reference group for support; the reference group here will be the financial market crowd. Immersion in the crowd reduces an individual’s anxiety, but increases the likelihood of major losses. People who experienced the February 2006 Saudi stock market crash fully understand the above-mentioned model. The crucial difference between those who succeed and those who fail is the will to separate themselves from the crowd and execute knowledge.
Separating yourself from the crowd insures that the vicious circle of anxiety and inappropriate actions mentioned above does not get hold of you.
To trade well you have to:
1. Lay down goals.
2. Gain knowledge of the markets.
3. Define your trading rules that work.
4. Execute in strict compliance to the rules.
Points 1,2 and 3 are easy, but their execution can be terribly difficult.
You need emotional self-discipline, to gain mastery over irrational impulses further more you need training to act in accordance with your set of rules.
The above discussion can explain to us why the majority of traders end up as losers, while only a small percentage are consistently profitable.
Successful traders have acquired the knowledge and mastered the will to execute knowledge.