Trading Psychology

Investor Behavior

Lots and lots of money can be made in the markets, but only if a person learn to control his inner emotions.

The stock market is mainly driven by just two emotions ie., Greed and Hope (known as Deadly Enemies in Stock Trading). After all, most of us have a desire to acquire as much wealth as possible in a shortest time.  This get-rich-quick mentality makes it hard to maintain gains and keep to a strict investment plan over the long term.

Greed is usually described as an irresistible craving to possess more of something (money, material) than one actually needs. Greed changes our way of thinking and just like we hold on until the market reserves on us.

When we take a position in the market, whether bullish or bearish, we Hope it will be successful. Hope can be such a powerful emotion, that when the same trading plan that told us to enter a position originally, reverses and tells us to exit immediately, our emotions may very well focus on the possibility that if we just hold on a bit longer, any loss may be erased.

We should make a decision based on the fundamentals and technical analysis and not based on greed and hope. Then only we can win the stock market with good system of trading.

Aiyan Thiruvalluvar says

ஆக்கம் கருதி முதலிழக்கும் செய்வினை 

ஊக்கார் அறிவுடை யார். (463)

कितना भावी लाभ हो, इसपर दे कर ध्यान ।
पूँजी-नाशक कर्म तो, करते नहिं मतिमान ॥ (४६३)

Explanation by Scholars: 

The Wise men will not, in the hopes of huge profit, undertake business that will consume their principal.

பெரும் ஆதாயம் (செல்வம்) கிட்டுமென்று எதிர்பார்த்துக் கை முதலையும் இழந்து விடக்கூடிய காரியத்தை அறிவுடையவர்கள் செய்ய மாட்டார்கள்.

ஆக்கம்கருதி = anticipating huge profit due to greed and hope 

முதலிழக்கும் = losing the principal 

செய்வினை = involving in an act 

ஊக்கார் = Won’t do 

அறிவுடையார் = Wise men

Overconfidence

Stock Trading

Overconfidence has been called the most "pervasive and potentially catastrophic" of all the cognitive biases to which human beings fall victim.

Confidence implies realistically trusting in one's abilities, while overconfidence usually implies an overly optimistic assessment of one's knowledge or control over a situation.

Overconfidence refers to a biased way of looking at a situation. When you are overconfident, you misjudge your value, opinion, beliefs or abilities and you have more confidence than you should given the objective parameters of the situation. It has been blamed for stock market bubbles and crashes. Overconfident investors generally conduct more trades.

Overconfidence can cause a person to experience problems because he may not prepare properly for a situation or may get into a dangerous situation that he is not equipped to handle. 

Aiyan Thiruvalluvar explains about implications of overconfidence with an excellent example

பீலிபெய் சாகாடும் அச்சிறும் அப்பண்டஞ் 

சால மிகுத்துப் பெயின். (475)

मोर-पंख से ही सही, छकड़ा लादा जाय ।
यदि लादो वह अत्यधिक, अक्ष भग्न हो जाय ॥ (४७५)

Explanation by Scholars:

The axle tree of a bandy, loaded only with peacocks' feathers will break, if it be greatly overloaded.

மயில் இறகுதானே என்று அதீத நம்பிக்கையில்  அதை அளவுக்கு அதிகமாக வண்டியில் ஏற்றினால் வண்டியின் அச்சு முறிந்து போகும்.

பீலிபெய் = very light weight of peacock feathers

சாகாடும் அச்சிறும் = the cart's axle will break

அப்பண்டஞ் = even though very light

சால மிகுத்துப் பெயின் = if loaded more due to overconfidence

Optimism and Overconfidence

Behavioral Finance

A bias towards optimism often leads investors to have an unrealistically positive view of themselves and their futures. The psychological biases of investors that are prone to overconfidence is perhaps the most damaging because our faith in our judgements usually exceeds their accuracy.

Such overconfidence is something investors must guard against. That is not easy because overconfidence is fueled by related psychological biases, called optimism, the illusion of knowledge and the distortion of hindsight. 

Optimism biases lead many individual investors to overestimate their investment results. Our optimistic nature is augmented by other factors that boost our confidence. It is our tendency to believe that the accuracy of our forecasts increases with more information.

The reason for overtrading is that investors feel motivated to master the environment. This is the illusion of control, the tendency to overestimate our ability to influence trajectories over which we have little control. Overconfidence is always problematic in bull markets, since the shares during this period show sustained stability. Our confidence takes hold, making us believe that the prevailing conditions will persist.

The wise investor not only knows how to recognize signs of overconfidence in him but also knows how to apply the brakes when the signs become visible. Overconfident investors tend to chase returns and underestimate risk.

Aiyan Thiruvalluvar says

நுனிக்கொம்பர் ஏறினார் அஃதிறந் தூக்கின்

உயிர்க்கிறுதி ஆகி விடும். (476)

चढ़ा उच्चतम डाल पर, फिर भी जोश अनंत ।
करके यदि आगे बढ़े, होगा जीवन-अंत ॥ (४७६)

Explanation by Scholars: 

There will be an end to the life of him who, having climbed out to the end of a branch, ventures to go further.

தன்னைப் பற்றி அதிகமாகக் கணக்குப் போட்டுக் கொண்டு, எல்லை மீறிப் போகிற ஒருவர், நுனிக் கிளையில் ஏறியவர் அதற்கு மேலும் ஏறிட முயற்சி செய்தால் என்ன ஆவாரோ அந்தக் கதிக்கு ஆளாவார்.