Written by Blain Reinkensmeyer
Edited by Carolyn Kimball
Fact-checked by Steven Hatzakis
March 13, 2024
Efficient markets are based on the assumption that rational people enter transactions with the intent to maximize gains and minimize losses. While this theory is sound, most investors are not the purely rational robots that efficient markets rely upon. Instead, emotions often cloud our decision-making and prevent us from acting in a rational manner.
Knowing we can never conquer our inherent emotional biases, we should seek to understand the range of emotions we may experience as investors and how it affects our interactions with the market. A common market psychology cycle exists that shines light on how emotions evolve and the effect they have on our decisions. By understanding the stages of this cycle, we can tame the emotional roller coaster.
This stock market emotions chart illustrates the 14 stages of the investing journey. Do any of them sound familiar to you?
- Optimism – A positive outlook encourages us about the future, leading us to buy stocks.
- Excitement – Having seen some of our initial ideas work, we begin considering what our market success could allow us to accomplish.
- Thrill – At this point, we investors cannot believe our success and begin to comment on how smart we are.
- Euphoria – This marks the point of maximum financial risk. Having seen every decision result in quick, easy profits, we begin to ignore risk and expect every trade to become profitable.
- Anxiety – For the first time the market moves against us. Having never stared at unrealized losses, we tell ourselves we are long-term investors and that all our ideas will eventually work.
- Denial – When markets have not rebounded, and we do not know how to respond, we begin denying either that we made poor choices or that things will not improve shortly.
- Fear – The market realities become confusing. We believe the stocks we own will never move in our favor.
- Desperation – Not knowing how to act, we grasp at any idea that will allow us to get back to break-even.
- Panic – Having exhausted all ideas, we are at a loss for what to do next.
- Capitulation – Deciding our portfolio will never increase again, we sell all our stocks to avoid future losses.
- Despondency – After exiting the markets, we do not want to buy stocks ever again. This often marks the moment of greatest financial opportunity.
- Depression – Not knowing how we could be so foolish, we are left trying to understand our actions.
- Hope – Eventually we return to the realization that markets move in cycles, and we begin looking for our next opportunity.
- Relief – Having bought a stock that turned profitable, our faith that there is a future in investing is renewed.
Individuals clearly follow this cycle in their decision-making process. Since broad indices like the S&P 500 reflect the decisions of millions of individuals, we should expect index prices to track this pattern as well.
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Key takeaway: If we are aware of the stage of the cycle we are experiencing at a given point in time, we will have a greater grasp of how our emotions are affecting our investment decisions. This knowledge will help us manage our own investment portfolios as well as predict the next step for the broad market.
Learn more: A great tool for building skills and learning how to invest more successfully is to keep a trading journal. I’ve rounded up my list of the picks for best trading journal apps here.
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FAQs
According to experts, successful trading is a result of 30% strategy and 70% of understanding Trading Psychology. So, if you are capable of handling your emotions and making full use of Trading, progress is not far for you in the Trading world.
What is the emotional cycle of trading? ›
Common emotions in trading
These usually come in cycles, from excitement and euphoria, to fear and panic, and then despondency and depression.
What is the psychology quote for trading? ›
“When you genuinely accept risks you will be at peace with the outcome.” Before you enter a trade, if you have a concrete risk management plan as part of your trading strategy, you should not sit by and worry as the trade develops. If you accept the risk you're willing to take, anxiety as trade progress will diminish.
What is trading psychology pdf? ›
Trading psychology refers to the aspects of an individual's mental makeup that help determine whether he or she will be successful in buying and selling securities for a profit.
What is the 70 30 trading strategy? ›
The strategy is based on:
Portfolio management with 70% hedge and 30% spot delivery. Option to leave the trade mandate to the portfolio manager. The portfolio trades include purchasing and selling although with limited trading activity.
Is 90 psychology trading? ›
It is often said that trading is 90% mindset and 10% skills. Having the right mindset is essential for any successful trader, as it helps to build confidence and consistency in your trading decisions. The right mindset can help you make good decisions quickly, remain disciplined and stay focused.
How to remove emotions from trading? ›
Here are five ways to feel more in control of your emotions while trading.
- Create personal rules. Setting your own rules to follow when you trade can help you control your emotions. ...
- Trade the right market conditions. ...
- Lower your trade size. ...
- Establish a trading plan and trading journal. ...
- Relax!
Trading Emotions. The most common emotions discussed by traders are greed and fear. In fact, some maintain that the only emotion that they contend with is fear: fear of suffering a loss, and fear of missing out on an opportunity. The actual array of emotions is far more complex than that.
What is the cycle of investor emotions? ›
Market cycle of emotions
Stock market returns have historically followed a cycle of emotions starting with strong returns when there is optimism and peaking when there is Euphoria. When fear starts to set in, market returns turn negative and eventually bottom out when investors are fearful.
How do you train trading psychology? ›
Conquer The Mental Game With These Time-tested Trading Psychology Tips
- #11 Don't Get Lost in the Numbers. ...
- #10 Accept That the Market Will Do What the Market Wants to Do. ...
- #9 Zoom Out In Review. ...
- #8 Cut Out the Noise. ...
- #7 Embrace the Risk. ...
- #6 Know When to Cash Out. ...
- #5 Know When You're Wrong. ...
- #4 If It Fits, Take It.
Key Takeaways. Trading psychology is the emotional component of an investor's decision-making process, which may help explain why some decisions appear more rational than others. Trading psychology is characterized primarily by the influence of both greed and fear. Greed drives decisions that might be too risky.
What are the psychological mistakes traders make? ›
3 psychological trading mistakes:
- FOMO trading: It is called fear of missing out, which means you are chasing a trade influenced by your emotion. ...
- Revenge Trading: Many traders get loss and think I need to recover my loss and took a trade on their opinion. ...
- Holding losing trade:
Understanding your trading psychology
For example, if someone is stubborn in their everyday life, that same stubbornness may cause them to hold onto losing positions for far too long, hoping for an against-the-odds reversal. This refusal to accept losses can result in substantial damage to your trading account.
What is a trader mentality? ›
Winning traders are flexible.
They aren't ego-invested in their trades. They are able to always view the market objectively and easily cast aside trade ideas that aren't working. Winning traders do not hesitate to risk money when they see a genuine profit opportunity based on their market analysis and trading strategy.
What are psychological levels in trading? ›
In summary, a psychological level in technical analysis is a price level that is perceived as significant by traders and investors, often due to its round number or because it has previously acted as a support or resistance level. These levels gain significance simply due to the attention traders pay to them.
What percentage of psychology is trading? ›
Being successful as a trader is 30 per cent strategy and 70 per cent psychology. It doesn't matter whether you decide the price of a share is going up or down: if you are not able to understand your emotions and use them to make the most out of each trade, then you will not get very far.
Is trading a game of psychology? ›
Trading psychology is the emotional component of an investor's decision-making process, which may help explain why some decisions appear more rational than others. Trading psychology is characterized primarily by the influence of both greed and fear. Greed drives decisions that might be too risky.
What is the psychological level of trading? ›
In trading, a psychological level is a price point in a financial market that holds significant psychological significance due to its round number (whole numbers that are multiples of 5, 10, 100, etc.) or key numeric value (price levels with market importance due to historical, technical, or trading activity reasons).
What is the psychology behind trading? ›
Basics of Trading Psychology
Fear, greed, excitement, overconfidence, and nervousness are all typical emotions experienced by traders at some point or another while trading. Managing the emotions of trading can prove to be the difference between growing your equity account or going bust.
