Trading psychology is the emotional component of an investor's decision-making process, which may help explain why some decisions appear more rational than others. Trading psychology is characterized primarily by the influence of both greed and fear. Greed drives decisions that might be too risky.
Understanding Trading Psychology:
Trading psychology can be associated with a few specific emotions and behaviors that are often catalysts for market trading. Conventional characterizations of emotionally driven behavior in markets ascribe most emotional trading to either greed or fear.
Greed can be thought of as an excessive desire for wealth, so extreme that it sometimes clouds rationality and judgment. Greed can lead traders toward a variety of suboptimal behaviors. This may include making high-risk trades, buying shares of an untested company or technology just because it is going up in price rapidly, or buying shares without researching the underlying investment.
Why Trading Psychology Matters
The performance of a trader's portfolio is linked to the investment decisions made, which are in turn affected by the trader's emotions, subjective inclinations and mental processes. Investment decisions may be arrived at through the use of fundamental analysis, involving use of data from a company's financial statements and regulatory filings, along with data on economic conditions. Alternatively, technical analysis, may be employed for decision making, involving the use of historical market price and volume data. Regardless of the type of data used, biases (subjective prejudices), and heuristics (unconscious mental shortcuts and patterns), can affect an individual's collection and interpretation of data. This can impact decision making and result in errors in judgement, potentially leading to suboptimal portfolio perfor