Stock market psychology is a term that often used by the financial media and analysts to explain market movement that may not be explained by other metrics; such as fundamentals. Market psychology describes the overall behavior of a market based on emotional and cognitive factors. Market psychology applies to all asset classes; from stocks, bonds, forex, interest rates, and cryptocurrencies. Stock market psychology is a well-thought-out powerful force and may or may not be justified by any particular basics or actions.
Understanding stock market psychology is important because, as a day trader, so you are able to identify and manage emotions and behaviors that may arise while trading. To benefit from stock market psychology, active traders should embrace the positive psychological factors while attempting to manage the negative aspects. It has been said that greed, fear, anxiety, and excitement call all contribute to market psychology. In this article, we will explore what drives the market, emotions, and volatility, so you can be better informed. After all, being better-informed leads to better decisions, which will help your trades.
What Drives the Market?
Interest rates are a driving force of movement in the stock market. Rising rates have a diminishing effect on stock prices. Unfortunately, many average investors underestimate the impact of rate movements on their investments until after the impact is felt. The financial news and the speed at which information is spread tend to increase market volatility and create overreactions from investors. The speed is typically very quickly due to the internet and since major stock markets overlap in market hours. Investor reactions to global events are seen in real time. When the reaction is negative, it can start a domino effect of sell-offs across regional stock markets, with an apparent never-ending cycle of market modifications and news updates.
Unfortunately, selling causes selling, which during a market correction may create a downward drive on stocks that can be difficult to break. The larger-than-life moves of a volatile market can rock the self-confidence of inexperienced day traders, who fear they will lose the money they have worked so hard to collect. Further complicating the playing field are professional short sellers; such as hedge funds or algorithmic trading programs. These entities take advantage of selling situations that are driven by human emotions by shaking out investors with a flood of additional selling pressure.
Emotions such as fear and greed can have negative effects that cause day traders to act impulsively. An example of fear-based trading can be seen when a trader closes a position prematurely. Fear may also turn to greed when a trader holds onto losing positions for a long period of time; fearful of taking or accepting a loss. Anxiety is something that is seen immensely in day trading. One main reason is that you don’t know for sure which way the stock market will go. The unknown tends to send people into a state of panic or worry.
Crowd psychology is also a factor in large market swings, which could trigger emotions, leading to fear-based trading. As panic increases, stock market volatility will follow shortly after. It’s human nature to not want to miss out or be left behind. An increase in volatility is usually followed by the fear of missing out (FOMO). An increase in fear will often lead to “panic selling”. Day traders will rush to get out of trades in an attempt to avoid greater losses. Or act hastily and rush into a trade, fearful of missed opportunities to make money.
Pessimism affects your mental attitude because it constantly feeds you negative thoughts. A negative mindset can lead to anger and depression and have a significant impact on your trading. It is also seen that pessimism seems to have a greater impact on volatility than optimism does. The other emotion day traders often face is the fear of losing everything (FOLE). While no one wants to be left out, a more powerful emotion comes from the fear of losing it all. Market volatility causes large swings in the stock market, Which causes day traders to become anxious; causing them to keep their money in the short term. They do this in an attempt to avoid a big sell-off or a stock market crash.
A good measure of volatility can be seen in market sentiment, which is a tool used to measure how investors see a market at a given time. When traders see the market as bearish, there will be more sellers than buyers in the market, which means that crowd psychology is negative. The clearest way to determine crowd psychology for stocks is through stock indices. A stock index tracks a collection of stocks within a specific country or market. Major stock indices are used to compare returns on different assets and to track the overall economy through the overall performance of the index. There are approximately 5,000 U.S. indexes. The three most widely followed indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite. The Wilshire 5000 includes all the stocks from the U.S. stock market.
Stock market indices are traded in large volumes and are very popular in the investing community. There are several benefits to indices for day traders and long-term traders. They are highly liquid, which gives traders tight spreads and clear chart patterns. They track changes in the economy, which can lead to great trading opportunities. Indices allow traders to predict the price of the index going up and down.
Summary: Psychology of the Stock Market
You have learned that psychological factors of investing can greatly influence outcomes on a personal and collective scale in the stock market. Emotional-based investment decisions and the shared impact of market swings can have a negative impact on your trading. Greed, fear, and anxiety are disabling to your growth not only as a person but as a day trader. That volatility, market news, and stock market indices are great things to keep an eye on when formulating your plan to enter a trade. If psychological conditions are not met, then a general rule is there will be another trade.
As human beings, it is normal to want to be part of something and belong. However, don’t let human psychology influence you negatively. Knowledge builds confidence but also obtains better results because you are staying well-informed. My goal has always been to help as many day traders achieve their personal financial goals, whether they are novice traders or experienced traders. I can teach you trading strategies that if you put in the work and practice, you will be successful for at least 80% if not more of your trades. The MK VIP training has plenty of resources to help you get started on reaching your day trading goals.
Maurice Kenny has helped over 600 people become financially free through one-on-one coaching, mentorship, and options trading strategy. Many of these new traders are now full-time traders, and they all started by watching his 1-hr webinar.
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