Understanding psychology of the stock market is just as important as understanding its economy
By Simon Chobod
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Whom should you ask for help in improving your decision making process? Who would know better?
Financial analysts? They themselves fail time and again to predict the market behavior with any degree of consistency.
May be we should change the direction of our questions?
May be the rules that govern the stock market behavior are not rational at all?
Who can give you a better counsel on that subject - financial analyst or psychologist?
It is in the human nature to trust general opinions formed by the social groups, to which we belong.
This is how we learned to survive as human species. In the primordial forests our ancestors had no claws,
no huge muscles, not even thick furs. Yet, by learning how to act together as a cohesive group,
they managed not only to survive, but to subdue all their enemies in the animal kingdom.
They forced their way to the top of the food chain by relaying on each other.
When we come to the new hunting grounds, to the stock market, we tend to form our judgments by relaying on familiar habits,
by trusting the prevailing opinion of the large group, in this case the majority of stock market investors.
If the price of a particular stock rises, we tend to change our opinion of its value.
If the group as a whole values this particular stock higher, then it must be worth more.
That leads us to a very important conclusion - all attempts to evaluate the stock market behavior
by using theories of rational behavior are bound to end in a failure.
The humans are not rational, and any attempt to build efficient market theories ignores this basic fact.
As we learned in the previous chapters, following the investing crowd is the best way NOT to make money in the stock market.
In the forest of the financial investments, we are no longer hunting together, we are hunting against each other.
If we want to be successful in this new game, we need to change the familiar patterns of our judgments.
Instead of blindly trusting the large group, we need to study its mass psychology.
We need to understand, what makes those intelligent people run together as a herd into new investing fads
or fall time and again for get-rich-quick schemes. Only by understanding the deep psychological reasons
for this irrational behavior, can we avoid being swept ourselves into a mass stampede for the wrong exit.
There are always investors, who profit from those events, and they are not part of the crowd.
They understand that emotions are responsible in large part for forming our decisions,
and by studying the reasons for those emotions, they keep their heads cool in the rational mood.
(This is an excerpt from my coming book on the psychology of stock market investing. What happens next?
That will be the story in my next article.)
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