The core of an effective and efficient trading market is thought to be interaction between rational individuals looking to maximize profits while minimizing losses. While this is a sound theory, it is not necessarily accurate. In fact, the majority of financial investors are not rational when trading and will often act on emotions when making significant decisions. It’s said that “going with the heart” is a good thing, but using emotion instead of logic during trading hours is not the ideal situation. Emotions cloud judgment and an inability to control these perspectives can affect interactions on the market.
Taking this into account, is there any way to manage the emotional situation and contain biases? Yes, there is. To understand our emotional state it is important to understand the range of emotions that can be experienced as investors. Trading psychology dictates a psychological cycle where investors go through stages of emotional experiences. As the stages progress, so does the emotional evolution and understanding the cycle can help us manage the rollercoaster. This article will identify the fourteen stages.
Optimism is an emotional perspective that encourages viewing the world through “rose-tinted glasses”. It promotes positivity regarding future endeavors and can result in purchasing stocks.
Excitement is experienced when we see our previous ideas produce positive results. The positive results encourage a consideration of how and what this success can help us achieve on the market.
Once hitting this stage, the investor is shocked by the successful results and begins commenting on the intelligence of the strategies.
After the initial feelings of excitement and thrill, the investor reaches a heightened state of euphoria. This is the stage carrying the greatest financial risk as all decisions will be made based on the belief of undeniable success. Decisions to invest will often be made quickly focusing on easy profits and ignoring any trading risk.
After the peak of euphoria, the feeling of anxiety will begin to rear its head. This is caused by the market moving against the investor and experiencing potential losses. Of course, as long-term investors clinging to the positive feeling of success, many investors will try to convince themselves that the market will turn.
Once the market has not rebounded and losses are incurred, denial will be experienced. At this point, investors are not able to fully accept their failure and deny the fact that they made poor decisions.
After facing the result of loss, the markets tend to become confusing to the investor and fear is experienced. A fear where investors believe they have lost everything and the market will never turn in their favor.
In a frantic move to regain success and profits, the investor will experience desperation and grasp at any ideas as a means to at least break even in the market.
Once all ideas have been exhausted and a realization of failure, a sense of panic will set in with the investor being at a loss of how to behave. The term “unable to think straight” comes to mind.
When experiencing capitulation, the investor decides that all is lost and no success will be experienced ever again. Many individuals choose to sell all stocks at this point to avoid future losses and protect what is left of their portfolio.
At this point, the investor will exit the market with a determination to never purchase stocks again in their lives. This is arguably the moment of lowest financial gain or opportunity.
Depression finds investors removed from the trading market and faced with time to consider their actions. Many analyze their situation and attempt to understand why they acted so foolishly.
After a period of time and analysis, investors will realize that the loss was not due to their behavior but due to the market moving in a repetitive cycle. At this point, the investor will feel a sense of hope and will look for new trading opportunities.
Relief is experienced once a stock is bought and profit gained. This renews faith regarding their future in investing.