Uncle Scrooge’s two most frequent emotions hold the answer – fear and greed
Some of you may have noticed that when prices start to fall, they seem to gather momentum and if the news they are reacting to is really bad – then it’s almost like a free fall. At the same time an upward movement is quite often done in increments or at a steadier pace. Although this doesn’t always happen, it does make an impression.
The explanation lies within two of the emotions traders experience (we covered their specifics in this article, as well as some of the others). First among them is fear. It is the driving force behind the selling of an asset and decreasing a position in it when there is bad news. Its increased amount among traders during certain periods can be explained with the nature of the emotion – it’s more primal and was developed in our brains in an earlier period than greed. Fear helped us survive by not taking unnecessary risks and attempting to evaluate all their potential sources.
Greed, on the other hand, can be attributed to what drives upward movement. As a secondary emotion it acts in a different manner – it accumulates and its representation is more delayed.
Keep in mind that this isn’t the evil and completely negative meaning of the word – it’s more like a component of wealth attribution, not necessarily being unfair.
In confirmation of this are the volumes of the traded instruments. Usually when the price is falling there are higher volumes. Fear is stronger and works in the moment, it grabs you and you feel like you have only one choice – this makes people exit entire positions. Buying an instrument and hoping it climbs up and brings profits is usually done in increments – some investors and traders add relatively small amounts to their positions over days, months and years.
We have to make several important notes here. Currency pairs are NOT an example of drops and climbs. As they are indeed pairs, the quick downward movement for the first currency in the way the pair is written, is at the same an upward movement for the second currency. As a recent example we can take the EUR/USD which has been dropping from last year’s high of 1.40 to around 1.13. If you search for the USD/EUR pair – it exists in unison with the more widely accepted representation – you can see that it has risen from 0.75 to 0.87 for the same period.
Second, but not of less importance, is that steep drops and steady climbs might not happen for certain commodities. As an instrument type they have their specifics – they are traded in futures and are ultimately used in the physical world. This makes the dynamics in their supply and demand different from those of currencies, indices and stocks. Not to say that the fear and greed dynamic is absent here – it just works differently.
Here are our tips on how to take advantage of your knowledge of emotions and their influence:
– don’t forget that you can profit from movement in both directions – keep an eye out for big turns both up and down. Even if you’ve performed an analysis or just made a judgement call for one direction, it might turn out to be completely wrong – instead of wallowing and accepting defeat, you can actually make a quick u-turn and jump on the opposite movement
– consider your emotions in advance of making a trade in either direction, don’t let too much fear or greed cloud your judgement
– use the stop loss and take profit functionalities
– exercise patience when buying, as it will take more time to reach a good level to exit
– be alert and keep a closer look on the market when you sell; things will most likely happen quicker than in the other direction
All this is, as usual, is easier said than done. Keeping your emotions in check, and at the same time, following the markets and their trends, breakouts and ranges is hard enough. These emotions will always be present as we are human, but if you do put them in perspective while trading then you’ll have an edge over other traders who are less aware of themselves.