3 Things to Know About the Psychology of Playing the Markets
Markets are in effect games of telephone - or rolling human perception.
Posted Feb 07, 2012
Most of us think that the markets are complex numbers games for which we have neither the time nor the education to truly understand. We hear the news reports of the Dow's swings and most of the time it seems disconnected from our daily experience so we invest in our 401K and leave the details to the so-called "pros".
Nevertheless there are three things from neuroscience that anyone who thinks about markets should know:
1. Markets are in effect games of telephone - or rolling human perception. Research shows that those of us who use our "Theory of Mind" or our ability to read other people may be better at predicting markets than those who use probabilities and math!
2. Whenever we think about a decision where the choice is fundamentally uncertain, our brains search for context. In using context, the brain draws from the external - or our recent experience - as well as the internal or our conscious and unconscious pattern recognition.
3. It's an absolute requirement to have an emotion to make any kind of decision - including the market, investing and trading ones where everyone will tell you to eradicate any emotion!
So what does this mean about how anyone can use psychology to more effectively interact with financial markets?
1. Whenever one thinks about buying or selling a stock they should ask themselves who is going to be buying it for a higher price or if they are selling, who is going to be selling it at a lower price? Looking at the question this way will keep you from buying at the top or selling at the bottom - the mistake most common for everyone but professional investors and traders.
2. It pays to know what your fractal emotional script is - (or in psychoanalysts' terms, your basic Freudian transference). It comes as quite a shock to people but it is true that markets become an authority figure or a spouse - and we then expect to get the same that we have gotten and for the "person" to react to us in the same way. This repetition, if it goes unnoticed, will skew our decision making process.
3. The most common emotion is fear not greed and fear exists on a spectrum. On one end you have the fear of losing and on the other the fear of missing out or future regret. (In fact, regret theory explains a lot about actual decision making in real human beings.) Chances are you will always be somewhere on this spectrum. That is fine - as long as you know it and can articulate that feeling. Doing so will help disentangle it from finding your best prediction of the real risk in any decision.
Always remember, markets may indeed be the most psychological inventions of mankind. Having a psychological strategy, as compared to a traditional mathematical one, can give anyone a leg up.