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domingo, 20 de septiembre de 2015

Psicotrading: The attitude to the financial markets matter

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Many times people who are new to the world of trading, are surprised at the importance of psychology in the trading process. Benjamin Graham, Warren Buffett's teacher, taught us this in his brilliant book "The Intelligent Investor", explaining that the market is a manic depressive, which metaphorically called Mr. Market.

In the investment world, the emotional component is absolutely key and in fact, the experts always speak of the emotional commitment of the trader when we analyze our price charts. The chartist formations try to identify the market's own thinking and, somehow, are behavioral group patterns, which results in mass psychology. This event causes prices to move by impulses and corrections, resulting in processes such as optimism, excitement, euphoria, greed, fear, denial of the evidence, despair, anguish, capitulation, relief and hope. The market is a crowd of people in a particularly hostile environment, in which we are all competing with a media noise that always complicates decision-making.

This year, the market has started, for example, with a strong increase of 20% in the first quarter, which means that the annual rate of increases was around 80%, something highly unlikely. These impulsive processes are developed in moments of excitement, often caused by positive news and a soft media environment that allows investors to gain confidence as prices are developed and, of course, reaching ever higher areas. The emotional state is fed, and the trader usually feel more comfortable when there's danger. Of course, impulsive processes reach saturation points and gradually the market is taking breaks.

Charles Dow in 1920 taught the first theory of technical analysis and in this work taught that the trends are composed by the sum of impulses and corrections, with durations of between 1 and 3 months and setbacks on key movements of one third, one half or two-thirds of the previous movement. This explains the importance of emotional control on the market, because if we look at money as the ultimate goal of our trading, probably we will fail to properly manage our emotions.

If we said before that greed and complacency take over the price as it develops and that, therefore, the more emotionally simple moments of entering the market are often the most dangerous, in the corrective processes the opposite happens . The first market corrections are often refused and simply be seen as a minor adjustment of the market to keep climbing until the denial of the evidence turns into fear, and as we know, fear paralyzes.

It is in this environment where we enter gradually in phases that can reach even the despair and panic, at which we sell our shares, with no other reason than to ease our pain. A professional trader can not make random decisions, not get carried away by emotions. A professional trader must understand the trading process as a set of rules to develop, knowing that what is important is to have a statistical advantage that allows to maximize profitability by the risk-return ratio.

As professional traders, we try to understand the emotional commitment of the market, looking for buying and selling points in the moments in which the emotional commitment is weaker and knowing what is the winning side.

For example, consider a bear market in which there is a investor who is trapped in the falling prices. Each new low reached by the price causes pain and despair for this trader. The investor feels sorry for the decision and is trapped in seeing how their capital is reduced in each session. Sometimes if market volatility is extreme, the investor can sell and capitulate as a result of excruciating pain.

When the price bounces and there are no more lower lows, the investor is relieved, as fear becomes hope, which causes a feeling close to optimism as a result of a process of relief and hope. However, this emotional commitment is weak and if the market turns again, the novice investor usually remember that dominant feeling of sorrow and regret again. This causes the inverter quickly close their positions.

It is in these areas of relief and hope that the more experienced investor usually find their entry points, since this weak emotional process is the main catalyst that feeds the trends as the economic cycle expands or shrinks, forming bullish or bearish tendencies respectively.

Therefore, experienced traders specialize in psicotrading, and is essential in a full speculator process, since understanding the charting as a science of analysis that interprets the behavior of the group helps manage our emotions, with the sole purpose of apply the rules of our trading system under a strict discipline in order to achieve all that we seek daily: consistency!

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