Crowd psychology

[cassiopeia]

I have just been reading an article in the Financial Times about crowd psychology. It’s the usual stuff about people being programmed to do exactly the opposite of what they should do in the stockmarket jungle, such as waiting in hope during a falling market or snatching at profits too quickly in a rising market. If true where have we inherited these traits from? why haven’t they been lost as a consequence of natural selection? and if these poor characteristics apply only to stockmarket decisions why is this so different than in normal life?

Humans are a tribal species, this has served him and his ancestors well through most of evolution. In most circumstances the power of the group is far greater than the sum of it’s parts so there is a tendency to stick together and copy one another. Perhaps the characteristic of panicking and rushing all at once is a natural reaction to confuse the predator, whilst to do nothing is a trait to avoid being seen and conserve energy. If so, these are poor survival instincts for the stockmarket.

We often hear advice such as “be a contrarian” and “the trend is your friend”, surely both of these cannot be correct. To me both these strategies are risky, the first could get you dragged down further, whilst the second often gets on the bandwagon too late. A much better way is to find the turning point just as opinion is beginning to change, although this can be very difficult in practice, so we have to combine this entry procedure with a system which will inherently produce profits by running gains and cutting losses. However, there is still an overwhelming urge to do nothing when confronted with losses and snatch profits when we shouldn’t, it’s those primeval emotions of indecision, fear and greed again.

I think more experienced traders eventually overcome these problems but are confronted with doubts about the validity of their strategy, as suggested in a previous thread. This makes one reluctant to enter the market rather than avoid stops. I think the only protection against this is to either use several strategies or/and employ an overall money management strategy where your exposure is related to your capital and risk.

 

[Trader333]

Natural selection can take thousands of years to produce the best model, the stockmarket is relatively young compared to that so it could be argued that it is still evolving. Also the stockmarket is made up of a species competing against itself, this doesnt generally happen in natural selection but it is true that the fittest survive.

Our upbringing doesnt help either. How many times as a child, or when growing up, have you been chastised for being wrong ? The psychology of this says that it is bad to be wrong, creates bad feelings and so we dont like to accept it when we are. This is opposite to what is needed in successful trading as you need to accept immediatley when you are wrong and do something about it. We are also taught that in order to profit we must buy low and sell high when, in fact, one of the most successful strategies is to buy high sell even higher and sell low and buy back even lower. It doesnt feel right but it has made good profits over the long term.

In addition to this you also have the fact that any market indicator is attempting to measure "Mass Polarized Human Psychology" that can change in an instant. It also requires someone to take the opposite view of the indicator for the trade to be enacted. So if someone favours an "Overbought" indicator to decide to sell then someone else will need to believe that the market is not overbought at this point and is going higher.

We also all view things through various filters and the more subjective they are the less likely success will come. I have seen some astounding posts on these boards for reasons given to enter a trade that were lacking any objective data and then surprise when money was lost. I know people may say that is just me with my own set of filters and I accept that I must have some. The only answer I can give to this is that I have been educated to make data driven decisions and to ignore opinion, including my own, if I cannot back it with fact. This has served me well in trading as it has made me focus on managing money rather than trying to be right when entering a trade. From all I have read, most people focus on being right and find difficultly accepting it when they find they are not.


Cheers


Paul

 

[nobrainer]

Excellent post! I'm a daytrader , self taught and have just read one book, which was a gift.I don't have any faith in charts and also think most TA is a total waste of my energy.
What I believe is the main aspect of my trading is to judge what ''the crowd'' will do and to do it before them.Most traders/investors hate to make the first move...they will wait for someone else to move a stock before jumping in.That's where I come in....I'll always try to judge a piece of news and trade it as I see it rather than wait for the stock to move in my percieved direction.Therefore many of my trades are done in SETS auctions first thing in the morning for example.
I really believe in preempting the ''crowd '' rather than joining them.Once you have done the trade all that's important is money management thereafter ie. setting stops before emotion starts to play havoc with your trade.
Being 1 of the crowd is a waste of time cos most of those suckers will lose money!!
LOL, just read your post , Paul.Pretty much the opposite to the way I trade...I hope it serves you well!!

 

[warm_machine]

Cassiopeia, you might find "Memoirs of Extraordinary Popular Delusions and the Madness of Crowds", written by Charles Mackay, to be of interest.

Nobrainer, you are quite right, knowing what the crowd will do/how it will react is priceless; a successful trading strategy can be based upon it. It's possible to explain the workings of crowd theory, but as no two situations are the same, I think realistically, the only way to acquire these skills is through experience. I say realistically because I think acquiring the services of a seasoned trader, with an understanding of the area, would speed up the process to some degree, but of course finding one willing to help an individual wouldn't be easy. And even then, I don't think it's something that could be picked up over a day or two.

 

[Skimbleshanks]

I think that first of all one has to define who or what the 'crowd' is. If the crowd is numbers of individual traders, then the crowd is usually wrong. However, if the crowd is the largest volume, then the crowd is usually right, because in this case the crowd consists of the big boys (institutions).

 

[nobrainer]

Skimbleshanks, no way I agree that the institututions are usually right or worth following .In fact, one tool I love to use in trading a stock is to always watch the trades to see when an institution has filled his order and then trade against him.
The best trades are always early in the day.ie preempt a move in the obvious direction....ride the move and then get out cos at a certain level the gas has gone from the move and you meet 2 way traffic.The institutional side of it , I think, is not relevant cos they are the trend followers and are not price sensitive.They are dinosaurs to a good trader.Also volume does not dictate short term trading direction imo.....that's the beauty of being a Level 2 trader.

 

[Skimbleshanks]

My apologies, I should have explained that my statement was based on observing US futures. Your comments I believe are based on UK stocks, so we're talking chalk and cheese :cheesy:

 

[Trader333]

Nobrainer,

I have, to date, only traded futures but I am preparing to trade US stocks where I will be using L2. I would argue that trying to pre-empt the move of a future and trading it before everyone else would result in ongoing losses. Focusing on the money management and managing a trade has worked well for me. The reason I have decided to change is that I have always been unhappy with the speed at which a futures market can move and with no warning. In my view trading stocks is a different ball game to trading futures and would suit me better.

I still think that money management is of critical importance and has played a large part in the successes of those people I have known who have consistently made money from trading.


Cheers


Paul

 

[Mayfly]

The Dirty Little Secret About the "Wisdom of the Crowds

Seems there isn't one: The Dirty Little Secret About the "Wisdom of the Crowds" - There is No Crowd

Sound familiar?

Enjoy

Cheers

Mayfly

 

[cogitoergosum]

A crucial aspect which is aften missed is that when it comes crowds are not usually wrong, it's just that they are unable to see when the trend is about to change. It's a very important distinction.
As somebody mentioned earlier, Charles Mackay's book is very interesting and provides many anecdotes of crowd manias. However, one book which forms perhaps the foundation of all subsequent thinking about crowd psychology is The Crowd, by Gustave le Bon, written in 1895. It's only about 140 pages, and provides deep insight into why this happens. My copy is Dover Publications. I bought it after it was recommended in Robinson's book Trading for Wealth, which contains a lot about trading psychology, and which I found very useful as it's applied to the markets, not just theory. (He recommends both books in fact, and also runs courses on the subject).

 

[KajolThappar]

yes or no and to certain extend.

Those people who trade by looking at technical analysis chart will sell and buy when the indicator they follow reach overbought and oversold level. if majority of people trade using technical chart then this is true.

experienced chart trader will not looking 1 or 2 indicators only, usually they combine a few to look for confirmation.

Great source for chart traders below

 

[born2winfx]

Great ideas thanks!

What I saw so far are that people overreact and are full of biases. Trader lie to themselves
Like a fish swarm the mass follows a trend and there are always a few in the end of the queue who get eaten.

 

[RedRenegade]

People do tend to overreact because the media hypes things up a bit... hence crowd psychology or so-called "social proof" that something is good or bad.