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Behavioral Finance Theory and Crowd Psychology
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Behavioral Finance Theory and Crowd Psychology

  #1 (permalink)
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Behavioral Finance Theory and Crowd Psychology

If any of you smart guys on the forum have any recommended books or courses on Behavioral Economics and Crowd Psychology, I want to hear from you.

I'd love a discussion on this topic!

How many of you believe that crowd psychology plays a major role in the markets?

Mike

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  #2 (permalink)
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  #3 (permalink)
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I want to call it "Price Psychology", because of actual patterns that are reflected in price action.

I hope you don't mind getting specific in this thread.

The broadest/best/most common one is a trap/failure. @Fat Tails and @tigertrader posted on this before, but I want to add my own angle.

1) Impulse on Momentum / Fear of Missing Out - The basis is human nature that doesn't like missing out on anything. So you have traders jumping on the bandwagon when there's an obvious momentum, because of the fear of missing out. This could be in any obvious spot, 1 tick above/below anything.

2) The LetDown - After the entry there is some follow-through, but typically it's weak. Imagining yourself being in that trade, you'd feel like 'praying'... trapped.

3) Stop Run - the poor enthusiasts from Step 1 watch the trade go against them. They feel sick. WHERE ARE THEIR STOPS? That's where you enter.

Yesterday's incredible sell-off started off exactly like that (YM). The market seemed to have a double bottom and ready to take off. There were bulls hoping to catch LOD (Low of Day). It was an obvious long at 56 above (reversal) bar 5 high. So some bulls bought there. The market reversed sharply, indicating it was more interested in HOD than LOD, punishing early bulls for an obvious lazy trade. It was an incredible short entry at 41. Perfect trade off a trap, waiting for others to shoot themselves in the foot.

(NB There were other considerations favoring a short such as a strong push into the close the day before, bear channel, test of the top of the bear channel, very weak bull doji bars 2 and 3...etc. It's best to combine both technical and psychological).

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Behavioural Finance

I honestly don't think markets are decipherable most of the time. I subscribe to the theory of emergence/spontaneous order:

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Behavioral Finance Theory and Crowd Psychology-behavioural-finance.pdf  

Last edited by Lornz; April 11th, 2012 at 05:29 PM. Reason: forgot the pdf
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  #5 (permalink)
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Something I often notice when I read through the thousands of posts on the forum. A lot of traders are exiting the trade at almost the exact worst point. They then "flip" direction and enter a new position, and again almost at the exact wrong point.

This seems to happen because:

a) They opened the position in the wrong place to begin with (impatience, inexperience).
b) As the position moved against them, they began to feel that they were wrong, and that the market was going to move against them in a big move.
c) They exit their initial trade.
d) They enter a trade trade, not wanting to miss this move.

Now we can all guess, that often the market does NOT take off in this direction, but instead comes back towards the original entry point from (a) above. Markets spend most of their time in a cycle of small up/down movements, yet a lot of retail traders seem to be trading these almost inversely.

I believe part of the solution is:

a) Have a plan. Have faith and confidence in that plan through a great deal of forward testing and analysis.
b) Have patience. Wait for the market to come up to a level you want to do business in.
c) Take the lesser risk of placing a trade at the "top" or "bottom" of one of the market cycles, and trade it in the direction of the bigger picture trend (days worth, certainly not minutes worth).
d) Don't be risk averse. Set a stop far enough away that once the market trades there you admit the trade was wrong, but not so close that if market trades at a nearby level and takes you out, that you don't feel the trade is still valid - yet you are flat.
e) Don't be greedy. Don't go for monster targets. I prefer to scale for this reason, taking part of my position off at a very reasonable move within the cycle, and leaving part of the position open should we breakdown or breakout.

Mike

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  #6 (permalink)
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Lornz View Post
Behavioural Finance

I honestly don't think markets are decipherable most of the time. I subscribe to the theory of emergence/spontaneous order:

Nice.

So let me ask you this:

If the majority of market participants lose money, what is your goal in terms of crowd psychology, or "emergence"? To fade the herd? But to fade them, you must still predict with some certainty what they will do, or at least have a plan of reaction once you identify what they are doing, so you can do the opposite.

Mike

Due to time constraints, please do not PM me if your question can be resolved or answered on the forum.

Need help?
1) Stop changing things. No new indicators, charts, or methods. Be consistent with what is in front of you first.
2) Start a journal and post to it daily with the trades you made to show your strengths and weaknesses.
3) Set goals for yourself to reach daily. Make them about how you trade, not how much money you make.
4) Accept responsibility for your actions. Stop looking elsewhere to explain away poor performance.
5) Where to start as a trader? Watch this webinar and read this thread for hundreds of questions and answers.
6)
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  #7 (permalink)
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Big Mike View Post
Nice.

So let me ask you this:

If the majority of market participants lose money, what is your goal in terms of crowd psychology, or "emergence"? To fade the herd? But to fade them, you must still predict with some certainty what they will do, or at least have a plan of reaction once you identify what they are doing, so you can do the opposite.

Mike

I don't care about who does what, really. I simply wait for signs of "spontaneous order", go in the direction it tells me and ride it for all that it's worth. I'm referring to volatile instruments like CL, of course. The ES, e.g., is a completely different beast.

The trade might be a fade, but it might simply be a breakout of consolidation. However, I always enter early -- not on upticks.

It's all about fat tails... (no, not you, @Fat Tails )

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  #8 (permalink)
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Lornz View Post
I don't care about who does what, really. I simply wait for signs of "spontaneous order", go in the direction it tells me and ride it for all that it's worth. I'm referring to volatile instruments like CL, of course. The ES, e.g., is a completely different beast.

The trade might be a fade, but it might simply be a breakout of consolidation. However, I always enter early -- not on upticks.

It's all about fat tails... (no, not you, @Fat Tails )

You caught my attention, what size fat tails do you like since German isnt one of them

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  #9 (permalink)
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Lornz View Post
I don't care about who does what, really. I simply wait for signs of "spontaneous order", go in the direction it tells me and ride it for all that it's worth. I'm referring to volatile instruments like CL, of course. The ES, e.g., is a completely different beast.

The trade might be a fade, but it might simply be a breakout of consolidation. However, I always enter early -- not on upticks.

It's all about fat tails... (no, not you, @Fat Tails )

Interesting.

Why is ES different from CL?

Mike

Due to time constraints, please do not PM me if your question can be resolved or answered on the forum.

Need help?
1) Stop changing things. No new indicators, charts, or methods. Be consistent with what is in front of you first.
2) Start a journal and post to it daily with the trades you made to show your strengths and weaknesses.
3) Set goals for yourself to reach daily. Make them about how you trade, not how much money you make.
4) Accept responsibility for your actions. Stop looking elsewhere to explain away poor performance.
5) Where to start as a trader? Watch this webinar and read this thread for hundreds of questions and answers.
6)
Help using the forum? Watch this video to learn general tips on using the site.

If you want
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  #10 (permalink)
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Big Mike View Post
Interesting.

Why is ES different from CL?

Mike

The most important factor is volatility....

CL is much easier to trade than the ES, but most people don't seem to get that.

I'm done with this thread now... I don't want to discuss anything too close to what I actually do!

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