Crypto Academy / Season 3 / Week 2 - Homework Post for Professor @asaj
Greetings,
How are we all doing? I read and understood the lecture taken by Prof. @asaj, titled "Market Psychology & Trading Psychology" and am so happy to be a participant in the class. In this post, I will be attending to the questions giving by Professor @asaj without waiting much of our time. So please, join me as I take you on the journey.
Part A (Case Study)
The case of a trader called "Jane" as the characteristics of "Trading Psychology". But before I give my reason why I believe the case study is an example of a case that explains trading psychology, I would like to explain the meaning of the two joined words Trading and Psychology.
Trading and Physiology are two separate words. That is, Trading is what traders do by deciding on a particular market price. Which may be either to buy or sell. While Psychology is the study of the mind and behavior. Putting these two words together brings about Trading Psychology.
Trading psychology is a broad term that includes all the emotions and feelings that an individual trader encounters when trading. Or an individual way of thinking that can influence the way they make a decision whenever they engage in trading.
In the trading psychology above definition, we can see the word "individual". That is, trading psychology in trading has to do with an individual way of thinking. On the other hand, Market psychology is the general agreement of the market as a whole based on the aggregate of individual market participants.
If should now compare the definition with the case of the trader named "Jane". It shows the emotion and her trading behavior as an example of trading psychology. We saw how she allowed are emotions to affect her decisions when engaging in the cryptocurrency trade. We saw how she makes a lot of wrong decisions because of her emotion, and Jane is not the only trader who thinks in that manner.
We have many other traders who think in this manner. I am once in this situation, but, I later took my mind off and forget I even invested. As we saw in the case study, Jane's trading psychology alone can not affect the market. When she decide d that she will no longer partake in trades, the trades continue going up and down. But if they are many people like Jane in trades who leave trades based on a little correction, it can result in a downtrend. And as the cumulative effect of several individuals trading psychology creates market psychology.
In the case of Jane, I will be listing and explaining 5 out of the biases that influenced Jane's trading behavior. It was not easy to get the bias except the ones that are obvious in the case, but, I choose to use the listed five below.
- Emotional Bias
- Herd Mentality Bias
- Self Attributes
- Confirmation Bias
- Bounded Rationality Bias
Emotional Bias:
This bias is really obvious in Jane's trading behavior, She purchases at first based on her feeling of high hope about the increasement of the crypto price. When the price was falling, she decides to buy more crypto coins based on her emotion. When the price refuses to increase, Jane became scared and later happy that he stop the loss triggered. But when the price started increasing, She started blaming herself and regretting she set a stop loss.
Herd Mentality Bias:
This bias is a psychological state of a person is acting and also justifying an action because everyone else is doing it. In Jane's case, she got the information to buy tokens on a telegram group without knowing much about trading. She bought the token because people are buying and gaining from it not because of her research. After when she bought the token, she became impatient and started selling the token.
Self Attributes Bias:
It can be defined as a fact in which a person disregards the role of luck or external forces in their success. We can also define it as a tendency of individuals to attribute success to their skills without the intervention of others and to attribute failure to factors beyond their control. In Jane's case, if she was able to control her emotion by holding the token longer than selling and Jane were able to accumulate profit. Jane would have to give kudos to herself because she has managed to get a big profit thanks to her skill in investing. But Jane failed with her investment because of her impatience and emotion. she blamed the market and she even blamed the stop loss that was been set by her.
Confirmation Bias:
Another bias found in Jane's case is confirmation bias. This is when someone decides to seek something to use as evidence to back up his decisions. Which may be either wrong or bad decisions, Ignoring the fact so as not to look wrong. In jane's case, when she started noticing the market downtrend and instead of her cutting losses, she uses or believes it's an opportunity for her to buy more coins. Truly, it is the best time to purchase more coins. But am very sure that, if someone as talked to Jane at that time, she would have shown them plenty of times in the Telegram group when the currency rose after falling considerably.
Bounded Rationality Bias:
This is a decision-making process where we only try to find the good enough instead of making the best possible decision. In Jane's case, Jane decided to sell off her token so that she will no longer stress or her emotions, but not the best decision for her to make because she was not able to earn when the price started increasing.
Avoiding Emotional Bias:
This is a type of bias in which traders make investments based on their feelings. In Jane's case, she invested her emotion alongside her finance.
However, the best way to avoid emotional bias such as fear, greed, hope, and regret, is to always purchase coin based on your research of the particular coin not based on what you heard from someone or a group chat, invest what you can avoid to lose, know that trading does not have 100% success guarantee, Avoid FOMO, That is, do not rush into a trade because of its trend. Make your research before you decide to purchase any token, so that you don't run out of trade like Jane and later regret it.
Avoiding Mentality Bias:
A trader can avoid herd mentality bias by having a good understanding of the coin to purchase and should not take anything at face value, or just because a telegram group or a prominent figure says he should do so. Also, as a trader, you must carry out technical analysis, fundamental analysis, and sentimental analysis. Though this does not give a 100% success guarantee, it helps in making decisions.
Avoiding Self Attributes
The earlier one accepts is a mistake, the earlier to learns more and makes corrections. In Jane's case, instead of her accepting that she has made several wrong decisions along with the trade, she was blaming the person that invented "stop-loss" for all of her losses. That is, the only correction she got from it, is not to use stop loss in her trade. Instead of her accepting her mistake and plan on learning more about trading.
Avoiding Confirmation Bias
One of the best ways to avoid confirmation bias is to accept your wrongdoing when you are wrong. Instead of proving you are right when you are not right. Only this will save you from a lot of troubles as a crypto trader and encourage you to learn more. Always know you have nothing to prove to anyone. If you win, you win and if you lose, agree and learn not to lose again.
Avoiding Bounded Rationality Bias:
A sound technical analysis with good research of the coins can help traders in making decisions in trades and predict the future value of the market. In Jane's case, Jane did not make any research or analysis, she only bought the coin based on the information she got from the telegram group. However, after making research, trader should ask his/herself if the market makes him gain more profit or not. If the answer is no, it would be best to stay off-trade and keep your analysis on, to know the best time to enter the market.
Part B (Research & Analysis)
In trading, we have three types of analysis which are: Technical analysis, Fundamental analysis, and Sentimental analysis. Among these three, technical analysis is one of the best analyses to use, because it has tools that can physically show the movement of the market. Such as moving average convergence (MACD), relative strength index (RSI), stochastic RSI, moving average MA. All these tools can be used in monitoring market psychology.
However, there are still tools that can be used to monitor trading psychology apart from the ones listed above, one of them is a candlestick. Candlestick can be graphically displayed in nature. It's displayed the price movements by using different colors to indicate the differences. Candlestick can be used to identify price patterns and make decisions based on the short or long time direction of prices. The green candlestick shows the upward movement or bullish movement. While red signifies the downward or bearish movement of the market.
Differences between trading psychology and market psychology.
Trading psychology and market psychology are two psychologies with different studies. Market psychology shows a general overview of the mind and behavior of all the traders. While Trading Psychology shows the Trading behavior of an individual trader.
Also, The effect of market psychology on the general market is gradual, as it takes into consideration the varying mindset of several traders. While the change in individual trading is seen immediately.
How can you measure market psychology using a crypto chart?
SourceAs we know that market psychology shows a general overview of the mind and behavior of all the traders. To answer this question, I will be using the trade chart for DOGE/USDT shown above to explain the general overview of the mind of traders.
Accumulation:
Source
The accumulation stage is when traders buy or accumulate coins in their wallets with a low amount volume. If we can remember the case of Jane, she also accumulated more coins during the fall/bearish/decrease of the token she purchased. In this stage, the price of the coin is not stable to buy or to sell and the price or value of the Crypto is trending to be flat. When we see this, we should that the crypto traders are accumulating coins.
Uptrend:
Source
After when the traders accumulated the coin in the first phase, they will begin to enter the second phase called the uptrend phase which can also be called the absorption phase. The phase is where traders purchase coins. While sometimes it may happen that some traders will start selling especially for those that have been waiting for an increase, the fear of losing will make them sell. I will not be surprised if this happens to Jane because the lesson I think she has learned from her loss is about the stop loss and if she has the opportunity to buy and later increase, the fear of losing may make her sell.
Distribution:
SourceThe phase which is the distribution phase is where traders start taking profit slowly. So, they take it slowly in other to still make their profit very high. If we can see the above chart, there is still resistance to whales where there are still many investors intending to purchase. They take it slowly to still make the price high.
Downtrend:
Source
This phase occurs as a result of distribution which is the third phase. This will make the many traders be leaving the market to see some profit. The phase is called Bearish.
Select 5 trading biases and explain with screenshots of any cryptocurrency chart how the biases can cause a coin to be oversold and overbought.
To answer this question I will be using some charts obtain from the Binance exchange to explain 5 trading biases that can make coins to be oversold and overbought
Herd mentality bias
As I have explained earlier than those that fall under herd mentality bias are those that take decisions based on the information obtained from others, not their research. We have seen this bias several times this year.
For instance, those time Elon Musk Twitter in favor of Dogecoin. This news makes many people engage in buying this coin. Their excess buying causes the price of the cryptocurrency to rise beyond what is expected and soon the market enters the overbought stage. Below shows one of an incident that Elon Musk tweets that caused Dogecoin to be overbought and an example of a tweet by Elon Musk.
Source
Confirmation Bias
Trader's decisions and beliefs by ignoring facts to the contrary can bring a cryptocurrency market that is in a Downtrend to an uptrend direction, if the investors keep investing in the coin, it can make a coin overbought or oversold.
Disposition Bias
Once several traders keep ignoring the signs of the market trend and instead keep holding their position just to prove a point, a time will reach when the market will fall below what they can endure, and at that point, they will begin to panic sell. This can make a coin to be oversold or overbought.
Emotional based bias
SourceThis involves basing decisions on individual feelings. In the screenshot above, the chart and the RSI show how the market was emotionally affected. If many traders who invest their emotion along with finance are in the market at the same time, the coin can fall or raise/ bullish or bearish as we can see in the RSI signal and candlestick chart. Which meaning emotion such as fear, hope, greed and so on can cause a coin to be overbought or oversold.
Self Attribution Bias
people with self-attribution bias usually rely heavily on self-skill and self-confidence before investing. Too much self-confidence in trading or investing can lead to failure. Because of this, a coin can be overbought or oversold.
Efficient Market Hypothesis conjecture or theory state that crypto and stock will always trade in a fair value in all exchange. That is, no exchange can sell any stock or cryptocurrencies at a different price because market prices only react to new information and no analysis can provide price minimization of an asset, as the market price is generally controlled.
Since the investor is not opportune to buy undervalued stocks or sell their stocks at higher prices than one of the general markets, their only option is to engage in the trading of stocks or cryptocurrency to make more profit. This is riskier as we all know. But before investor engages themselves in trading, they need to carry out a risk assessment on the trade.
Advantages of Efficient Market Hypothesis
Save money of innocent
The efficient market hypothesis makes it clear to the investor, that the stock market should be viewed as a speculative game and not a place where investors can earn a consistent abnormal return by buying undervalued stocks and selling overvalued stock.
Neutralizes Self Made Experts
Another advantage of this theory is that once you know the stock market is efficient and reflects the true value of stocks that you will not get into the trap of buying blindly any stock based on the recommendation of self-made experts who go on social media to deceive people.
Disadvantages of Efficient Market Hypothesis
Skills and training are required to engage in it:
To engage in the financial market, good skills and training are required. Knowledgable people can not just decide to start trading crypto or collectibles, if anyone does, that means the person is gambling his/her money because he does not know what he's doing.
Markets are Irrational
This is when stock markets were available at a throwaway price and people made a lot more by buying stock or cryptos at throwaway prices. However, an individual can make money by buying undervalued stocks during the market crash and selling overvalued stocks during market exuberance.
In conclusion, Market psychology describes the overall behavior of a market based on emotional and cognitive factors and should not be confused with trader psychology, which refers to the same factors but that affect just a single individual.
I also want to say a very big thank you to Professor @asaj for the wonderful lecture because it has added to my knowledge. And to all those that will be reading my post,