Psychology and Herd Behavior
Guest post by Macro Story;
Trader psychology is arguably one of the most important aspects of a successful trader yet one seldom understood let alone studied. In the book Beyond Greed And Fear (Hersh Shefrin) I found two interesting discussions relevant to the current market.
Most traders view themselves as above average, able to move independent of others with superior skills.
“In a survey, drivers were asked how good a driver are you. Relative to the drivers you encounter on the road you are (a) above average, (b) average or (c) below average. Between 65 and 80 percent of the people who answer the driver question rate themselves above average. Of course we all want to be above average but only half of us are.”
“People have very poor intuition about the behavior of random events. With gambler’s fallacy, they expect reversals to occur more frequently than actually happens.
I usually divide students in my MBA classes into two groups. I ask everyone in the first group to take a coin, toss it one hundred times, and record the sequence of heads and tails that result. I ask everyone in the second group to imagine that they are tossing a coin, and to record the outcome of an imaginary sequence of one hundred tosses.
Then I collect the responses of each group and analyze each student’s response according to the number and length of the runs (consecutive heads or tails). What is the point? The imaginary tossers do not generate enough long runs as compared to the actual tossers.
People believe that most strings of coin tosses feature the same number of heads and tails (in reality they do not) thus they expect short runs.”
Why is this relevant to today’s market? Look around and listen to traders. Bears have waited for years for a market rollover and after 7% they cannot “see” further downside and are capitulating. They are covering shorts and questioning if they should in fact go long.
The vast majority of traders who view themselves as “above average” able to trade the market in front of them reminds me of a school of bait fish, constantly reacting with no sense of direction.
In the words of Jim Rogers “there are some who speculate mainly on the basis of commodity charts and technical analysis. They swear by various mathematical models and theories. Good luck to them. Frankly, in my experience, I`ve known few people who have gotten rich off technical analysis.” (Livermore)