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Some thoughts on human psychology - fear & greed

We humans are affected daily by psychology in one way or another.

Psychology as a science is the systematic exploration of human experience and behaviour. This is very much linked to investment and money.

Fear and greed are two of the most common psychological aspects we are exposed to when trading in financial markets. Fear that escalates when things don't go as planned and greed - a desire for more when things go well. Below we take one concept at a time and work out what actually happens when things go really well or really badly.

Greed/greediness

A mild form of greed can be viewed positively and is often what makes us want to invest or trade in the market in the first place. It creates an interest in something where you see a potential return on your money. It could be that you get a tip about a stock, that you see a result from a trading robot or that you see a value in a new cryptocurrency. Regardless of the type of market, there is an initial interest in investing yourself when you see a clear potential to get a good return on your money.

If greed had stopped at that stage, greed would only be positive, but unfortunately this is not the case. Suppose you buy a stock that after 3 months has increased in value by 10%. This return is usually said to be an average return on the stock market over a year and now you have received it in just 3 months. The thought that usually occurs to most people is "I should have invested more". Instead, take the example that you invested your money in a trading robot and during the same 3 months got a return of 15%. There it is easy to think "if I increase my attitude a little more, I can get even more return". That's when greed becomes dangerous.

When you see something doing really well and above expectations, it's easy to lose touch with reality about what can be considered a 'reasonable return' versus 'lucky coincidence'. Usually, this is when you start acting irrationally, buying more shares when they have already risen in value or increasing your setting in the robot to chase even more returns on your money. At the same time, what happens when you do this is that you increase your exposure and your risk - to a level higher than the one you initially planned.

Many people can probably recognise themselves here. When something that has gone very well over a long period of time suddenly starts to go downhill. The stock drops in value and the robot's trading affects your capital more negatively than it did before, and you have invested more than you first thought. Fear starts to creep up on you.

Fear / fear

The psychological aspect of fear arises when the investment does not go as planned. The stock you bought more than planned has lost value so that you now have a value of -10%. The robot hasn't made a profit for months and is glowing red with negative pending trades. In this situation, humans tend to both feel worse mentally and act irrationally and both stem from two things - greed and emotions. If you have invested money you can't afford to lose, you are likely to have a greater emotional attachment to the money and therefore feel fear - because you don't want to lose it.

It is also common to want to blame someone else or something external instead of going back to why things turned out the way they did and why the investment is failing. They would rather find a scapegoat than take personal responsibility.

Fear also tends to lead to impulsive and less thoughtful behaviour. In the above example, this can mean selling your shares or manually closing your trade positions without thinking or analysing and thus realising a loss. Very often the investment turns positive quite shortly after a fear-based action. The result of the investment is that even though the stock or the robot was a really good investment, it was a loss for you as you fell victim to the psychology - greed and fear.

Fortunately, there are ways to minimise the risk of being overly influenced by psychology and emotions. Diversify your investments in different stocks or different robots so that you are not completely dependent on one doing really well. Never invest money that you can't afford to lose. You need to be able to disconnect your emotions from your invested money, and the best way to do that is to not feel like you need the money to get by on a day-to-day basis.

And finally - patience. If something goes very well, be grateful for the return you get at a limited risk and avoid increasing your risk by overexposing yourself. Instead, take your time and be disciplined and patient!

// Svenska Forexgruppen