In the fast-paced world of finance, where numbers and figures continuously move around screens, psychology is typically the furthest thing from one’s thoughts when it comes to trading and investments.
But, in reality, it is the human mind, together with its emotions, certain biases, and cognitive patterns, that lies behind the wheel of every such decision.
This section aims to shed light on:
- What is trading and investment psychology?
- The impact of psychology on trading and investment decisions
- Common psychological biases that can impact decision-making in the financial realm
What is Trading and Investment Psychology?
Trading and investment psychology investigates the complex relationship among emotions, prejudices, and actions that have an impact on financial behavior. It starts with the idea that people are not naturally rational, particularly when it comes to finance. Our behavior is often motivated by mental triggers like fear, greed, or confidence, as well as social cues.
The Influence of Psychology on Trading and Investment Decisions
No matter how beneficial a trader’s decision is about selecting a reliable trading platform like Plus500 UK, many other aspects play essential roles in defining its success. After watching the video, the most important factor that should be considered is psychology.
Here are several common ways in which psychology influences trading and investment decisions:
Decision-making
In particular, it often depends on how afraid, greedy, hopeful, or sorry a financial agent feels. For example, due to FOMO, or “fear of missing out,” financial agents enter the market without proper analysis or research anywhere.
Cognitive Biases
These are shortcuts our brain takes to process information quickly. However, it often leads to irrational financial decision-making.
For example, confirmation bias – when a person actively looks for information that confirms their beliefs. It interferes with the ability to accurately assess investment prospects.
Behavioral Finance
It is a field that combines psychology and economics to understand how people make financial decisions.
The assumption is that market trends and patterns are often due to people’s behavior rather than rational factors.
Emotional Discipline
To be successful, a trader and an investor should be able to manage their emotions and make decisions based on facts and analysis.
They are also aware that emotions affect the process of making a decision, and they are able to cope with them.
Common Psychological Biases in the Financial Realm
In addition to the above fear triggers, there are also several common financial psychological biases that can also impact one’s trading and investment decisions. Most of these are a combination of fear and greed. They include overconfidence, loss aversion, and herding.
- Overconfidence: Tendency to overestimate at making decisions and overstate their knowledge and abilities. When trading and investing, it can suggest risk-taking and diminished compliance with warnings: “Emotions are an excellent indicator that signals you to start your strategy from scratch.”
- Loss Aversion: The tendency to perceive the pain of losing more than the positive of winning, leading to risk aversion: “The FOMO money tends to consider investing in Amazon not because of its forecasts, but because of the fact that the biggest money in the world is generated from it.”
- Herding: refers to the propensity of humanity to follow the masses. In other words, this suggests that with regard to acceptance, people want to perform at a reasonable level. However, in their view, the financial readiness does not actually exist.
- Endowment: This is the tendency to value something more highly simply because we own it. In the realm of investing, this tendency can result in individuals retaining underperforming investments due to emotional attachment.
Conclusion
Being aware of these biases is the first step towards overcoming them and making more informed decisions.
It’s important to do your research, consider multiple perspectives, and avoid being influenced by the crowd or emotional attachments.
By understanding and actively working to overcome cognitive biases, investors can improve their decision-making skills and potentially achieve better results in the long run. Remember, the market may be unpredictable, but our own biases are something we can control. So continue learning, adapting, and making rational decisions in our investment journey.
