Guest post by Susan Porter. Many traders in today’s investment marketplace have negative psychological traits that can work against them. As prevalent as these traits can be, traders may not even be aware of how such negative traits can prevent them from making bigger returns.
Negative psychology is rooted in cognitive biases, or behavior patterns that distort judgment. Almost everyone experiences these biases, and in economic market situations, they can frequently be a hindrance. They may create a negativity that limits rational evaluation, or causes us to believe we have unlimited rationality. Because of this, economic and investment judgments are often less than rational. This leads to over confidence in investments or panic when one is doing poorly. It also leads directly to something that’s a key part of human behavior both in and out of the economic marketplace: loss aversion.
In fact, our aversion to loss is so strong that we believe we have control over our own behavior, when frequently we have no control either externally or as self-control. Our lack of self-control shows up in trading terms when traders reveal a tendency to overstate their resistance to temptation.
Selfishness, too, is a negative psychological trait, that can cause overestimating or underestimating of either value or risk of an investment.
Big returns on investments can be limited by loss aversion, selfishness and many other negative psychological traits that a trader – like any human being – can exhibit. There are cognitive biases in a number of areas that effect a trader’s actions and returns.
One common bias is the ambiguity effect, which causes one to avoid options that include missing information – thus a trader won’t invest when the probability of return is at least apparently not known. Another is the tendency to anchor, or rely heavily on a piece of information utilized in the past. Clinging to past marketplace evaluation is a sure fire negative for big returns, given the volatility of the marketplace.
A trader who exhibits a behavioral backfire effect will react to what should be new, altering information by instead strengthening their own existing beliefs.
Don’t forget that secular bear markets can last for a very long time. The 1907 “panic” has so far been “replicated” by the 2008 crisis (still active). The 1907 crisis lasted for a very long time. Yes, this time is different, but not everything is better now, but one thing constant is the stupidity of people. From DShort.