Market Psychology is the idea that the fluctuations of a market reflect the emotional stage of the investors. It is one of the main topics of an interdisciplinary field that investigates the different variables that precede economic period called behavioral economics.
Many are under the perception that emotions are the main driving force behind the shift of the finance & crypto markets. The overall varying investor & trader sentiments are the so-called psychological market cycles.
In reality, when the market goes bull, it is likely due to an improving personality & confidence among the traders. A positive market causes demand to increase & supply to decrease. Further, the increased demand may cause a stronger attitude among the traders. Similarly, vice versa in the case of a negative trend.
Market Psychology usage by Investors & Traders
If the market psychology is valid, understanding it will help a trader to know when to enter or exit a market at favorable times. Generally, the attitude of the market is counter-productive- high financial opportunity when the market is down & vice versa.
Traders & investors use this info to buy when prices are low & sell when prices are high. But, recognizing these points is not as easy as pie.
Technical Analysis & Market Psychology
Analyzing previous data makes it clear what decisions or action items would have been profitable. But, in fact that’s not the case.
The market change is difficult to understand & even difficult to ascertain the next plan of action. Many investors use Technical Analysis (TA) to get an idea where the market is heading.
The TA indicators are essentially tools that can be used to obtain a measure of the psychological state of the market.
Common thinking patterns that often cause traders to make rash decisions are called Cognitive Biases. Some common examples are-
- Loss Aversion- the common tendency of investors to fear a drop in profit more than a gain. This often causes traders to miss good opportunities to make profits during the period of market capitulation.
- Endowment Effect- The tendency to overvalue things that people own simply because they own it. For example, an investor that owns crypto is more likely to believe it has more value than someone who doesn’t own crypto.
- Confirmation Bias- Can be defined as the tendency to overvalue information that confirms what investors already know. Strong market investors will focus on the positive news while ignoring bad news or negative symbols that market will fall.
Most traders & investors will say that psychology plays a critical part in impacting the market cycle & market prices. Investors need to be vary of not only the market psychology but their personal psychology as well & how it will affect their decision-making ability.