CHAPTER 25

Investor psychology

LEARNING OBJECTIVES

After studying this chapter, the practitioner and student should be able to:

  • Understand how trends and market tops and bottoms develop with respect to various psychological and emotional biases
  • Identify the behavioral elements associated with trending action and the underlying reasons for why trends tend to persist
  • Identify the behavioral elements associated with consolidations and the underlying mechanisms responsible for ranging action and breakouts
  • Identify the behavioral elements associated with market reversals and the underlying reasons for irrationality at tops and bottoms.

The study of trader and investor psychology is critical to the full understanding of market action. In this chapter, we shall look at the various behavioral elements and mechanisms that are responsible for the manifestation of trend action, consolidations, and market reversals.

25.1 GENERAL BEHAVIORAL ASPECTS

Psychology, Emotions, and Investment Decisions

It is a well-accepted fact that the market is driven by expectations. In other words, the market is driven by the expectation of future prices. Expectation itself is a consequence of various beliefs, biases, habits, knowledge, attitudes, and emotions. Fear, greed, and hope play a very large part in trading and investing. Peer pressure and other third-party influence may also affect investment decisions. Experiencing significant life events is another factor that may alter one's outlook and investment ...

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