Warren Buffet, an American magnate who is considered one of the most successful investors ever with a net worth of eighty-four billion dollars, states that “The most important quality for an investor is temperament, not intellect.”To be successful in the investment world, one does not have to be a mathematical genius and somehow conquer the market. It is not about who can decipher more quant models or who can create the perfect algorithm. It’s about having profound respect for the market’s ultimate weapon of choice… human behavior.
Failing to try to comprehend and appreciate human behavior and its consequential aspects within investing is the most common stumbling block of investors.The rare genius all great investors share is a percipient understanding of the instincts, emotions, and tendencies of investment behavior. Such behaviors are fear, greed, discipline, risk-taking, hope, regret, bias, and experience. Although some traders can be negatively affected by greed and fear when trading stocks, traders who understand the emotions behind their trading, known as trading psychology ultimately produce better tangible results.
Emotions in the financial market
The financial market is driven by the emotions of its participants and when in low trading activity quantiles, fear is one of the most prevalent components that contribute to market volatility.The presence of fear in a person’s mind controls their behaviors, making them refrain from taking risks or by acting irrationally, consequently decreasing their net outcome. When watching the market, it starts to move but some people may wait to come in due to caution.
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However, by waiting to long and missing out on the entry, that fear turns into anger as well as FOMO(fear of missing out). In the end, eventually investors are driven to bid up pull prices and reduce hedge risk.Refraining from risks make the bear markets palpable which causes fear that eventually morphs into panic and results in bad selloffs. Using this understanding of fear, making the decision to go with a calmer stock that has a lower average daily range will produce a more steady flow of money. Therefore increasing the pride and confidence in a person to then retry going into the market and producing better results.Fear is known to be a dominating emotion over greed in a negative way within low trading activity quantiles.The aggregate fear gauge, another name for it is the VIX method, functions as a barometer of risk for financial assets. The method is a weighted index that comprises the implied volatility of put and call options.(Lo,2013) Inside the market, the term “fear”is used because investors are risk averse and fearful of uncertainty. When investors suffer large losses, they become more fearful of further losses. To stem their losses, investors quickly sell portfolios in search of less risky assets such as money market securities and principal-protected funds, which are low-risk, low-return securities. When traders fear losses, they start selling stocks. These sales drag down stock prices heavily, causing financial markets to crash irrationally. As fear creates uneasiness in both the market and the trader, the comprehension of where it comes from allows for more progress to be made towards decreasing volatility and therefore, increasing profit made.
In trading, greed is an emotional response to price fluctuations and dramatic changes in an investors wealth that short circuits a person’s brain making them reckless.Automatic emotional responses of the brain trump high level or more controlled responses such as logical reasoning. The emotional responses short circuit the more complex facilities of the brain resulting in poorer trading performances.(Lo,2015)In high trading activities greed has the biggest influence over a person’s decision making.Logical reasoning is at a disadvantage in terms of being put to use. This further perpetuates the idea that controlling anger will allow for your brain to discern what logical reasoning is and to put it into action. Logical reasoning creates more opportunities to reap benefits from the market. Fear can be a temporary emotion while greed is permanent in its presence in the market. Greed has the ability to take over when the market approaches a high. When using the approach of greed, in a bull market, stock prices start rising sharply because of heavy purchasing based on speculations about a possible uptrend of prices. In the final phase of bull markets speculation runs rampant and investors throw caution to the wind. Fear and greed coexist and have mutual implications on the market. Greed is a driving force that pushes people in a positive way but keeping that line is very hard to know how when people don’t understand if they are feeling greedy or motivated.
Fear and greed
Fear and greed lead to the appearance of regret in a traders behaviors that results in the loss of trading discipline. Ignorance and false hope stem from the regret felt after a infelicitous trade. Financial spread betting sets up a situation to imagine. Say a trader gets into a trade after missing out because the stock moved too fast. Direct losses from security prices are falling from peak highs which allows for the violation of trading disciplines to occur. (Ayondo,2016) After losing a trade a sense of disbelief and depression may wash over you causing a loss of control of the emotions. Regret over that loss causes that disbelief to then turn into the idea that all that needs to be done to fix the problem is earn all the profit back.The problem is not the loss it is the failure to recognize one’s own ignorance. In a state of such false hope they disregard any trading strategy or plan that they once had in order to flail towards what they can grasp back. The emotions take control of the person rather than the person being in control of their own emotions. Regret ends an unproductive cycle of emotions(fear,greed, anger, and regret/ignorance) a trader experiences that leaves no positive results behind. Gasteren shares a story about how after fearing missing out on a trade a man goes in at a bad time which then turns into the greed of wanting to get a good deal and then anger when nothing works out. Finally at the end due to regret, ignorance and false hope bubble and fester only to come up and cause the man to refuse to sell the stock and keep taking hits from the one that has fallen due to false belief of it ever going up, This eventually causes the trading account to be wiped.(Gasteren,2016) The end of the cycle leaves room for hesitance to fester until the next time you try where that hesitance then messes with your brain. Refusing to handle these emotions sets up a career of frustrations and failures in the trading game. To be able to handle them will prove to be a fair wiser decision in both the short term and long term effects.
Creating a trading plan and using discipline to follow it while keeping emotions in check creates a healthy paradigm of success. A trading plan is something, a type of method, that is systematic which is used to identify and trade securities. The plan takes into account variables such as time, risk, emotions, and an investor’s main objectives. ( A. Dimarcio,personal communication,2018) Discipline is crucial in following a trading plan as it pushes away foolish ideas and feelings that are trivial and cause stress. The most successful trader that was known by Michael Hebenstreit was a man who, when on the trading floor never spoke to a soul and strictly and religiously followed his trading plan. He was a day trader and cared of nothing but focusing solely on himself and keeping calm and collected. He wanted no one’s opinions as well as his own feelings to be involved in his trading plan. From the viewpoint of Mr. Hebenstreit, the man was “killing it”.(Hebenstreit,2018) The man’s determination and strength of mind wielded incredible results. Creating a correct head space for a person’s mind is essential to combating emotions. Without knowing what they face, a person is more susceptible to giving into them. When correctly faced, people give themselves a higher percentage chance of a more increased return on their investments. A trading plan highlights a person’s ability as well as increases their luck in receiving higher revenue than a person without a plan.
Bias
Bias is another example of an ingrained psychological response such as emotion that influences people’s actions but when overridden can generate positive effects. There are two different types of biases that are relevant to the trading market which are cognitive and emotional bias. Cognitive bias can be taken as a rule of thumb. An example that was given was in the movies where a thief uses a police officer uniform to trick other officers into believing he is one. The assumption done on the part of the real police officers through correlating the outfit to the job is cognitive bias.(Staff,2018) A specific type of cognitive bias is called confirmation bias where more weight is put into the opinions of others that agree with the person in question and lessen the importance of the other opinions that disagree. However, the desire to combat this is rewarded by having an analyzed and researched stock be either confirmed or denied to be a lucrative offer. Emotional bias is action that is based on feelings more than facts. Overconfidence can be an example of an emotional bias. Believing that their personal abilities are high can be detrimental, especially to a less experienced trader. In a study done by LuukVas Gasteren, overconfidence “leads to an increased risk taking, increased leverage taking, and overpaying by the individual…”(Gasteren,2016) While there is no way to eliminate bias altogether, there is a way to minimize its effects to a low degree where the production of money is able to happen to certain degrees. By setting trading objectives and rules whilst never deviating from them, the chances of progress in a person’s trading account is more than possible. Overriding emotions is a difficult task that is hardly done without an abundance of experience. However, professionals have learned that taking the time to develop this skill is the only way to not only survive in the market but to thrive in it.
Negatively charged emotions and behaviors
Negatively charged emotions and behaviors such as fear and greed can result in direct losses. However, using them in a positive way can produce the opposite result. Greed has been said to completely take control of people and cause people to recklessly go into deals and buy certain stocks that don’t benefit them in the slightest. One case of greed rearing its ugly head is when someone is “…investing too large of a percent of your overall trading funds on one position.” (Ayondo,2016) This is caused by previous successes that then breeds greed and selfishness. Oppositely, using those successes in the proper way to breed motivation rather than self-indulgence will affect the outcome of the trade positively. It will allow for the person to recognize when to move in and out of a position in respect to the market. Sasha Evdakov uses sports as an analogy for how greed can be a positive motivator when being self aware. He states that when playing a sport such as basketball or football, being greedy actually means being driven in order to achieve goals that means something to them. Desiring or craving for something that results in personal gain or wealth is not always a bad thing.(Evdakov,2016) An excessive amount of greed or fear will amount to unclear decisions as anytime there is emotion involved, there is irrational thinking. Sasha Evdakov states that “…that is where the problem lies within the stock market, is when we’re extremely greedy or fearful because we are attaching things to our personal selves and looking for monetary gain.”(Evdakov,2016) By being content and satisfied with what greed does, a trader will feel more security in their trading. This security will then spawn success of a higher degree. Evdakov contradicts the statement previously made by saying that “…It’ll[comprehension] bring that success into a higher percentage success and the earnings will increase, because the times that are always the toughest is when things are going really well and all of a sudden greed takes control only to witness that the stock starts to pull back in a big way…” (Evdakov,2016) Traders face desperate situations that can be easily avoidable by compelling themselves to look at where the problem lies. In this case, it is the detrimental effects of greed, fear, and other behavioral aspects that cause negative outcomes. Realizing their problems and confronting them will prevent those outcomes and ensure a higher chance of beneficial results.
Emotions go through everybody’s mind at least a thousand times per day. Traders are one of the most important people to understand that idea. Prosperity and affluence in the trading world are dependent on those emotions. It is essential to respect the idea that human behavior needs to be comprehended and appreciated as it is the market’s weapon of choice. Failing to do so can result in consequences that may be irreversible and fatally damaging financially. Such behaviors can include risk-taking, discipline, greed, fear, hope, regret, ignorance, and bias. All investors that are successful have a basic grasp of their own instincts and tendencies that fuel their investment behavior. Warren Buffett lives as a trader that follows the idea that “Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”
Greed in Business. (2022, Feb 02). Retrieved from https://paperap.com/greed-in-business/
