Crypto Academy Season 3 | Intermediate Course:Homework task for [@asaj] ; Market Psychology & Trading Psychology
Part A (Case Study)
The case study given is an example of what type of psychology? Explain the reason for your answer.
The case study given in an example is a type of psychology known as "trading psychology". The reason for my answer is simple and that is because the decision taken by Jane was her own. She bought the recommended cryptocurrency at $9 on the basis of signal given in the telegram group. Jane is an individual investor of that cryptocurrency and individual investor's psychologyy is known as "trading psychology" and not the market psychology. Jane is not the only investor of cryptocurrency within that frame of time, there must have been many other. Jane's trading psychology couldn't sync with majority of other traders psychology over her investing time period.
Using the case study above, list and explain at least 5 biases that influenced Jane's trading behaviour with examples of how it affected her behaviour?
The 5 biasis that affected Jane's trading psychology are listed below :
Emotional Bias.
Disposition Bias.
Confirmation Bias.
Self-Attribution Bias.
Herd mentality Bias.
Explanation with respect to Jane.
Herd mentality Bias
As you can see in the above list, I mentioned
herd mentality bias at the end but here I am explaining it first because of a definite reason and the reason being that the first purchase of the cryptocurrency that Jane made on the basis of the recommendation of the group of people in the telegram group falls in the herd mentality bias.
Herd literally means "a group of people" . So the purchase of recommended cryptocurrency at $15 by Jane was based on no research by her. It was wholly and solely driven by the recommendation of a handful of people in the telegram group.
Emotional Bias
Of the four major types of emotions bias mentioned by professor @asaj , Jane encountered following types of biases.
Greed of earning more profit prevented
jame from selling her cryptocurrencies at $20 after few days of purchase. Allthough hike in price from $15 to $20 in was a good profit percentage for Jane to bag but it was her greed that prevented her from selling at that point and therefore had to face the adverse outcome thereafter .
On price sinking of recommended cryptos , Jane's attempt to average out her position was somewhere at the back of her mind driven by "greed and hope". She had hope of forthcoming price hike so as to average out her position and she also had greed of bsgging more profit .
Disposition Bias
It is not necessary that at one time only one bias influence the decision of an investor. Similarly, in case of Jane multiple biases have influenced her trading decision. Dispositiion bias came into play when Jane tried to average out her position and purchased more recomended cryptos on watching sinking price of Cryptocurrency. She tried to justify her position by not only holding the already purchased cryptos but by purchasing more cryptos too.
Confirmation Bias
It is a type of bias that doesn't hold true only for cryptos but it also applies to our day to day life also. It can be understood as something when someone tries to justify their irrational beliefs by taking support of temporary, transitional , poorly established or coincidental facts. Jane was happy after solding her assets, when price kept dipping dowm with the belief of having done good to have sold her assets earlier and therby preventing herself from any major loss.
Self attribution
Bias.
Self attribution bias is a very wonderful and interesting concept of psychology. I think all of us must have experienced this bias many times in our lives. Self attribution bias actually highlights the inherent tendency of the human to attribute the success to their personal capabilities and failure to the factors outside their control.
When I was a child and my parents used to enquire about my performance in exam. On performing well, i used to demand gifts from parents for having worked hard to get to that position and whenever I was not scoring upto the mark, I was putting blame on the syllabus by saying that the "questions were out of syllabus". That was my self attribution bias of linking poor performance to syllabus and good performance to my hard work.
Look at the Japanese statements
Who the heck created stop loss?" she yells. "It is such a dumb concept,"
Attributing her faults to stoploss and her success to her capabilities on sinking of cryptos after her stoploss was hit. So it is a self attribution bias.
How these biasis affect her behaviour.
If i collectively sum up the results of all these biasis, i would say she ended up her trade in loss and her behavior kept changing from hope of gaining profit to begin with, to the greed of gaining more profit to anxiety and fear of price drop to frustration of loss and later back to near normal state due to price hike.
List and explain how each bias you have mentioned can be avoided?
Strategies to avoid biases.
Don't let your emotions control you.
Do your own research.
Spent only affordable amount.
Diversify your portfolio.
Be neutral towards market.
Don't follow advice of self styled experts.
Emotional bias can be avoided by taking control of your emotions. That is possible in crypto world by having indepth knowledge of market. One should be aware of the volatility of crypto assets and keep in mind that neither bullish nor bearsish trend is permanent.
Had jane been able to control over her greed, she could have booked about 33% profit within few days of her purchase. Had she been able to understand the market psychology , she wouldn't have made additional purchase without proper research and she should have also made use of traiing stoploss after properly arranging risk reward ratio.
<br Herd mentality bias can be avoided by developing indepth knowledge about Crypto market , so as to be able to make analysis of the market yourself to the extent that you are confident but not overconfident about your decisions in order to avoid relying on others for signals.
Disposition bias can be avoided by developing a "neutral attitude" towards trading. You as an individual investor can manipulate your emotions but your emotions cannot supersede the whole market . So by developing the neutral attitude, if you end up doing something wrong, it is better to confess and look for the reason for that mistake and then try to rectify the mistakes instead of trying to justify the mistakes by committing more blunders.
Confirmation bias can be avoided by not jumping to conclusions but instead develop a habit of discussing with your competent peers and gathering information from multiple sources before making any conclusion
To avoid self attribution bias , one should learn to accept failures as humby as success and try to learn lessons from the failure. One should bot lose hope and give up because it is said that "success is going from failure to failure without losing enthusiasm". Instead of trying to hide behind external factors, one should confess the failure and look for the measures to rectify the factors that contributed to the failure.
Part B (Research & Analysis)
What type of analysis can be used to monitor market psychology and trading psychology, and why? Identify the differences between trading psychology and market psychology.
Technical analysis is the best tool to identify and monitor trading psychology and market psychology. Market psychology is not an alien concept but it is the aggregation of the trading psychology . To put it simply, we can say that market is not determined by an individual trader instead by all the traders together at a particular point of time. Individual psychology of the each trader cannot alter the market moment unless the individual trading psychology synchronises with the psychology of other traders and that is when we call it trading psychology. So the concept is basically the same and therefore the tools to monitor are also the same.
With the Boom in technology and years of experiences of the investors, people came up with some wonderful trading tools by the name of indicatorsthat are intended to show current market trend as well as are used in predicting future market movements. Therefore these indicators are potential tools in the hands of individual traders to govern their psychology and make it synchronise with the psychology of the other traders and therefore mimic the market psychology.
Difference between trading psychology and market psychology.
Trading psychology refers to the sentiment, behaviour and emotional state of an individual trader towards the market , on the contrary market psychology refers to the overall sentiment, behaviour and emotional state of all the traders in a market at a particular point of time.
If trading psychology doesn't synchronise with market psychology , the trader doesn't get desired results
Individual psychology of the retail investors do not determine the market moment , instead psychology of the Financial Institutions can turn the table.
How can you measure market psychology using a crypto chart? Select 5 trading biases and explain with screenshots of any cryptocurrency chart how the biases can cause a coin to be oversold and overbought. (Add watermark of your username)
Measurement of Market psychology .
To measure market psychology, we are talking about qualitative measurement because psychology can't be quantified. Multiple factors come into play during different phases of market psychology. Let's talk about few of them.
There is an index called "Fear and greed index" Which cam help us to some extent. This index is based on simple logic and is mostly used in stock markets but holds true for cryptos too to greater extent ( Alternative. Me website for cryptos ) . This index would measure whether an asset is fairly priced or not. Different psychological factors have different bearing on the market for example fear tries to bring the price of an asset down because traders resort to overselling due to fear and that pushes the price of an asset down. On the contrary, greed pushes price up because traders do over buying because of greed. An arbitrary value of 0 to 100 has been assigned to it. Where 50 is neutral and greatee than 50 indicates greed and less than 50 as fear. This indicator takes mamy factors into consideration like market volatility, price momentum, strength etc.
Relatice strength index has definite values to measure whether an asset is overbought or oversold. A value of less than 30 indicates that an asset is oversold and a value greater than 70 indicates that an asset is overbought. As indicated in chart above, overbought and oversold regions have been marked with arrow heads and look at the subsequent price chart that reflects exactly the same way. Similarly MACD indicator can also be used to measure the market psychology based on crossovers between MACD and signal line. If MACD crosses signal line from below upwards, it indicates buy signal and vice versa. For our task, we can call buy signal as positive emotions and sell as negative emotions.
Trading Biases
Look at rhe screenshot of BTC/USDT below. Has 2 phases involving different biasis as marked within boxes on the image .
Uptrend
Uperand represents the positive sentiment within the traders and therefore increase in bull pressure. The bias that take over traders during the bullish phase are greed, trust, FOMO, optimism and euphoria Multiple combination of these factors motivate traders to buy these assets more and more and therefore push the asset towards overbought zone.
Downtrend
We can see in the screenshot above that uptrend does not continue forever but is followed by downtrend because the sentiment created during the uptrend is now replaced by other factors like greed of booking profit and than fear of devaluation followwd by anxiety / pamic untill the asset is pushed into oversold zone.
Trend chasing bias is seen towards the top of uptrend, when the traders bought the asset with the hope or chasing the trend but they soon lamded in trouble with the launch of bearish trend.
Herd mentality bias could be expected to have experienced during the initial down phase because some of the traders couldn't quench their sentiments created during positive phase and continue with that herd mentality untill they ultimately witnessed clear bearish trend.
In your own words, define the term efficient market hypothesis (emh). List and explain the advantages and disadvantages of efficient market hypothesis (emh).
Let me put forth my understanding of Efficient market hypothesis , the Efficient market hypothesis states that "marketts are efficient enough to reflect all the information in the price of assets". I think it would be easier to correlate by thinking about the share market price during covid-19 pandemic outbreak. Share market in our country declined by about 40% with the outbreak of covid due to multiple reasons . As for the cryptos are concerned, we are all aware of the recent crash in the Bitcoin and altcoin price after some negative news came out about crypto ban in China and some Tesla related news.
So the point to be understood from Efficient market hypothesis is that "it is not possible to earn consistently abnormal reward from the market or in other words, I can say that, it is not possible to consistently beat the market because the information is absorbed in the stock prices by default and disseminated to whole of the market . The abnormal return here means the return that beats the market and is technically known as "Alpha return". So we can say that, it is not possible to constantly earn Alpha return by a trader.
According to this theory , the only way to earn high return is to take higher risks or to do riskier Investments or diversify portfolio by random stock selection.
Different forms of EMH
Weak EMH
Weak EMH talks about technical analysis, we know that on the basis of past information of an asset technical analysts have developed potential tools to predict different parameters of market. According to weak EMH , as past information of the asset is reflected in the current price, so by making use of technical analysis, you cannot beat the market consistently to earn high rewards.
Semi strong EMH
This form of EMH refutes use of both technical and fundamental analysis for the purpose of earning Alpha return.
Strong EMH
This form of EMH refutes technical and fundamental analysis as well as and private information available to any insider traders. None of these information can help trader to constantly earn high rewards.
Advantages of EMH
Save money that people spend on learning technical and fundamental analysis.
Eliminate the chances of falling prey to experts arising out of blue.
Saves time that people spend checking balance sheets and other Fundemtals and learning technical analysis .
Disadvantages of EMH
We can find examples of some great personalities who skyrocketed by buying undervalued stocks and selling high. So markets are not always efficient.
Fundamental and technically analysis does work and we have numerous examples or some of us may have noticed change in their balance sheet prior and post learning of analysis.
Saying that market is speculation or gambling is a fallacy. No trader or investor blindly invests in any asset that comes their way. All spend time doing some research at their own level and that is what makes difference.
In case of cryptos, there is no concept of intrinsic value that can be taken as standard to compare price with .
Just for sake of completion, let me mention that there are certain tests based on calculations to check validity of EMH and they are Runs test, auto correlation studies, residual analysis and event studies.