These past few days, the market has been like a roller coaster, first experiencing a significant drop, then a strong rebound in the last two days. Friends who bravely bought the dip yesterday should be reaping substantial rewards today. However, some friends may still be holding positions. If they had added to their positions at the bottom, recovering their investment and making profits is within reach. But before rushing to sell, consider the valuable experiences of the predecessors below.
In trading, many people have a 'chronic problem': when making money, they panic, afraid that the easy gains will fly away, rushing to cash out; when losing money, they stubbornly hold on, hoping for a miraculous market reversal to recover losses. This is not just a weakness of a few individuals; the vast majority of traders easily fall into this psychological trap. To delve into the underlying reasons, one must recognize a famous figure—Daniel Kahneman. His research acts like a sharp scalpel, dissecting the hidden thoughts we have while trading, providing traders with a deep 'psychological insight'.
Who exactly is Kahneman? He is a Jewish-American psychologist who, despite not being involved in traditional economic fields, won the Nobel Prize in Economic Sciences in 2002. His 'Prospect Theory' directly overturned the traditional economic assumption of the 'rational economic man'. In simple terms, our decision-making is largely influenced by emotions and psychology, rather than relying on rigorous logical deductions and precise calculations.
The three key laws he summarized clearly explain the pitfalls in trading and can help us optimize trading strategies.
The first is the 'Law of Small Numbers'. Never be misled by short-term fluctuations. We all have a habitual mindset; as soon as we see a bit of price fluctuation, we rush to predict the overall trend. For instance, if stocks rise for several consecutive days, we assume they will continue to soar. Kahneman calls this the 'Law of Small Numbers'. In actual trading, many people focus on the price fluctuations of the past few days, operating based on feelings and completely ignoring the long-term trend and macroeconomic fundamentals. For example, some forex investors blindly conclude that a currency pair will rise significantly simply by looking at data from the past two weeks, while ignoring central bank monetary policies and key economic data. Remember, market judgments should rely on solid evidence, not on guesswork.
Secondly, there is the 'Expectation Theory'. People crave stable happiness. People's preference for risk depends on the situation. When making money, they tend to be timid and want to cash in as soon as there is a profit; when losing money, however, they can be reckless, hoping for a miraculous comeback. This is known as 'certainty preference' and 'risk aversion'. Take Bitcoin in 2021 as an example: it soared from $20,000 to $60,000. Many early investors hastily sold as soon as it exceeded $20,000, missing out on the excellent opportunity to double their investment. Kahneman pointed out that people often focus more on immediate gains and overlook long-term potential.
The third is 'loss aversion'; the pain of losing money is indeed hard to bear. This is the most frustrating part: our internal pain from losses is much stronger than the joy of making the same amount of money. This 'loss aversion' psychology directly causes us to lose our composure when losing money. During trading, when there is a loss on paper, many people are reluctant to cut their losses, hoping for a market rebound, even increasing their positions to lower their cost, often leading to deeper losses. For instance, during the global inflation surge in 2022, many commodity futures traders, unwilling to cut losses and averaging down, ended up breaking their capital chains, being forced to liquidate, and losing everything.
So, how can we correct these issues?
To overcome the 'Law of Small Numbers', one must cultivate a long-term perspective and not be swayed by short-term fluctuations. Develop a trading plan and do not let market noise interfere with your judgment.
To alleviate the worries caused by 'loss aversion', one must set stop-loss and take-profit points in advance and strictly adhere to them. At the same time, manage your positions well to control risk within an acceptable range, leading to a naturally calm mindset.
Adjusting expectations is equally crucial. Do not always fantasize about making guaranteed profits in the market; accept the uncertainty of the market. When holding a trend position, hold steadily and do not exit easily.
It is also essential to recognize one's own irrationalities, learn a bit of behavioral economics, and understand your psychological weaknesses. You can also use algorithmic trading tools or consult professionals to avoid emotional interference.
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