Behavioural Finance: 5 Times Traders Need to Get a Grip on Themselves

Becoming a successful trader is all about striking a balance between excess and defect. Somewhere in between fear and greed lies a perfect medium that gives traders the fortitude to overcome their emotions.

Below we look at five scenarios where a trader may lose his or her grip on reality. If you find yourself in one of these scenarios, snap out of it!

Overconfidence

After making a few successful trades, you’re suddenly on top of the world. While confidence is necessary to produce solid returns, too much of it can burn you really badly. Traders who are overconfident in their abilities are much less likely to employ risk management techniques. They are more likely to rely on feelings and emotions or haphazard analysis that usually end up costing them in the end. Get a grip on yourself! You may be a good trader, but probably have a way to go before you can live off a few trades a month.

Overreaction

Have you ever spent hours or days waiting for an important event or data release? Has the outcome ever surprised you, leading to a knee-jerk reaction? Well, you’re not alone. While it’s important to anticipate key events and react to them accordingly, an overreaction benefits nobody. According to the market efficiency theory, new information is more or less reflected instantly in a security’s price. It’s important not to contradict that theory – so keep your response measured.[1]

Overwhelmed

Sometimes, the flood of financial information may seem overwhelming. Technical trading, fundamental indicators, geopolitics, an upcoming holiday – where does the true price lie? Rather than pull your hair out, remember that you have a trading plan that is intended to guide you through market turbulence. There’s no time like the present to implement it. If the technical and fundamental indicators aren’t supportive of a deal, then why would you take it?

Feeling Skittish

Nothing wrecks investor confidence like a big loss or a major market selloff. As recent times have clearly demonstrated, volatility has a way of creeping back into the market over and over again. Rather than feel skittish, remember to take practical risk mitigation strategies. Stop-loss orders and take-profit points can give you the confidence you need to trade the markets after a bad loss or volatile event. There’s no need to feel skittish!

Herd Mentality

Nowhere is herd mentality more prevalent than the financial markets. Herd behaviour has pretty much defined the major events in our financial history. If somebody else is doing it, I should also be doing it, right? Wrong! If you find yourself swayed by what other people are saying or doing, it’s time to step back and re-evaluate. The social pressure of conformity should be avoided at all times.[2] In fact, if there’s one place to be a non-conformist, it’s the financial markets.

Feeling overconfident, overwhelmed or skittish are never a good sign if you are a trade. Overreacting to news events or following the herd are equally as damning. If you ever find yourself in this scenario, remember to come to grips with yourself. Get back to basics, review your trading goals or re-evaluate your trading strategy. This will help you avoid catastrophic mistakes.

[1] Albert Phung. “Behavioral Finance: Key Concepts – Overreaction and Availability Bias.” Investopedia.

[2] Albert Phung. “Behavioral Finance: Key Concepts – Herd Behavior.” Investopedia.

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