Large funds exploit retail investor psychology to create various trading traps. Once understood, you will find that success can be replicated because you have the tools to overcome mental barriers.
Here is a simple listing of the 8 major principles of trading mentality.
1. Anchoring Effect:
Over-reliance on easily obtainable information. The anchoring effect is particularly common. For example, if the coin price rises from 5 U to 50 U, you will anchor at 50 U. When the coin price falls back to 30 U, you will think it's cheap, and when it falls back to 20 U, you will think it has hit the bottom. You completely forget the concept of 5 U, whereas 20 U has already quadrupled. The anchoring of prices creates an 'illusion' of expensive and cheap, leading to decision-making errors.
2. Loss Aversion:
A strong preference for avoiding losses. Simply put, you check your investments daily when they are rising, but you are unwilling to open the trading software when they are losing.
The pressure brought by losses is far greater than the pleasure of making money. This is because you entered the market to make money, never thinking about incurring losses. The aversion to loss can easily distort your trading operations. Whether in the stock market or the cryptocurrency market, fluctuations may cause you to wait indefinitely, hoping that losses will disappear and turn into profits.
3. Sunk Cost Effect:
Putting more emphasis on money already spent rather than money that might be spent in the future. The sunk cost effect mainly refers to the tendency in stock trading to add to losing positions rather than giving up once a loss occurs. This is because giving up means that an unrealized loss becomes a realized loss. However, you need to understand that the drop in coin price has already brought about a real loss; not selling does not reduce the loss.
Holding positions merely represents the fluctuation of coin prices and has a relation to your profits and losses. Sunk costs are present not only in the cryptocurrency market but anywhere you make contributions; there will always be sunk costs. They greatly influence a person's trading mentality.
4. Disposition Effect:
Realizing profits early, yet allowing losses to continue. The disposition effect is similar to loss aversion; it refers to the tendency during trading to sell rising stocks more easily while holding onto falling stocks. Often, we are reluctant to act on losing coins, always expecting market rotation to pull prices back up to reduce losses. However, the reality is that losses may persist, and profits may also continue; incorrect dispositions can still lead to significant losses.
5. Result Preference:
Judging the quality of a decision solely based on its outcome, without considering the quality of the decision itself. The biggest issue with result preference in the stock market is mistaking luck for skill. If you buy a stock and make money, you may feel you did the right thing, without considering the quality of the decision itself. If you made the decision simply due to luck, you won't be able to summarize any patterns. We need to focus more on the quality of the decision itself and reflect on the correctness of each buy and sell.
6. Recent Preference:
Placing more emphasis on recent data or experience, while ignoring earlier data or experience. Recent preference appears in the cryptocurrency market where one might make money for a while and then not make money after some time. We all pay great attention to current market conditions and trends, but we can't ignore past data and experience. Recent preference may provide significant assistance during a phase of short-term market trends, but in the long term, it may lead to pitfalls.
7. Trend Effect:
Blindly believing in something just because many others believe in it. The trend effect is more common; most people choose to trade cryptocurrencies because of the trend effect. Simply following the crowd to buy coins, without ever considering whether they should be trading or if it suits them to enter the cryptocurrency market. When buying and selling coins, it is easy to be influenced by the decisions of those around you, thereby following the crowd. This trend effect has led to herd behavior, resulting in many retail investors being harvested by institutional funds.
8. Law of Small Numbers:
Drawing unfounded conclusions from too little information. Many people may have heard of the law of large numbers; in fact, trading stocks is about the law of large numbers. The law of small numbers refers to the idea that a few successful investment experiences do not represent true success. For example, if you make 3 investments and succeed in 2, you think your success rate is 66%. If you make 5 investments and succeed in 3, the success rate drops to 60%. If you invest 50 times, your success rate may only be 50% if you succeed in 25. The law of small numbers represents random investment success, influenced by luck; to achieve long-term success, you must repeatedly invest for validation.
Summarized the investment mentality; whether it's investment or speculation, it really isn't necessary to distinguish them so clearly.
Playing in the cryptocurrency market requires learning and expanding your understanding. But one thing to remember is that it is difficult for people to understand things beyond their own knowledge. Let's encourage each other!
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