Hello, Tigers!
In the last lesson, we learned three methods to find opportunities for profit during times of panic. I believe you've gained a lot from it. In this lesson, I will talk to you about three common traps in behavioral finance and how to avoid them, so you can win in long-term returns.
1.Refuse emotional trading
The first trap: Emotional trading.
Emotional trading is one of the common trading pitfalls in behavioral finance.
Simply put, emotional trading refers to irrational decisions made by investors in the face of market fluctuations due to emotions such as fear, greed, or anxiety. These decisions are often driven by emotions rather than rational thinking.
Emotional trading can lead to many trading mistakes. For example, when the market is volatile, some people may hastily sell out of fear, while others may blindly chase after gains out of greed. Such emotionally driven trading behavior often leads investors to miss opportunities in the market, or even incur huge losses.
Furthermore, behavioral finance suggests that investors' emotional fluctuations are closely related to market price fluctuations. Emotional trading often leads to sharp fluctuations in market prices, creating a herd effect among investors.
This effect makes market fluctuations more severe, and investors are more likely to be trapped in an emotional quagmire. It's like a blind collective dance without a clear direction or goal, ultimately leading to chaos in the entire market.
Therefore, to stand invincible in the financial market, we need to overcome our emotions and avoid emotional trading.
A calm and rational mind is the cornerstone of investment success. By deeply understanding our investment style, setting clear investment goals, and always maintaining a calm observation of the market, we can navigate through the ups and downs of the market with ease.
2.Avoid overtrading
The second trap: overtrading.
Why do we need to avoid the trap of overtrading?
Imagine a small boat in the ocean waves. If it changes direction frequently, it will be difficult to navigate through storms. Similarly, in the financial markets, avoiding overtrading is as important as maintaining a course.
From the perspective of behavioral finance, there are four main reasons to avoid overtrading:
Firstly, overtrading is like being overly excited when surfing, seeming thrilling but full of danger.
Behavioral finance tells us that frequent trading often means high trading costs, much like paying a hefty price every time you surf. Whether it's commissions, taxes, or market friction costs, these will erode a portion of the profits that investors should have made. Excessively active trading behavior is like surfers constantly bobbing up and down in the waves, eventually exhausting themselves.
Secondly, overtrading often reflects investors' overconfidence.
Behavioral finance believes that people tend to overestimate their ability to gather and analyze information, much like surfers overestimating their ability to conquer all waves. Frequent trading decisions may lead investors to be overly confident in the market, believing too much in their predictions, and ultimately losing direction in market volatility.
Thirdly, overtrading easily leads investors to lose themselves in the fog of short-term fluctuations.
Behavioral finance points out that short-term market fluctuations are often unpredictable, much like the surging of waves in the sea. Investors who trade frequently may make hasty decisions based on momentary market sentiment, neglecting the importance of long-term investment.
This is like surfers only seeing the waves in front of them, ignoring the vastness of the entire ocean.
Fourthly, overtrading may lead investors into the trap of speculation.
Behavioral finance research shows that investors who overtrade are more susceptible to market noise and irrationally follow market hotspots.
This is like surfers only focusing on local areas of the sea, ignoring other places more suitable for surfing.
If investors chase after hotspots too frequently, they may miss out on more stable investment opportunities, ultimately falling into the quagmire of losses.
3.Avoid participating in "Greater Fool" trading
The third trap: participating in "Greater Fool" trading.
What is "Greater Fool" trading?
Traditional finance teaches us to stick to long-term value investing. But in the real market, most investors still prefer short-term trading. This phenomenon can be explained by the theory of "Greater Fool." The theory was proposed by Harrison and Kreps in 1978.
The core belief of this theory is that investors buy an asset not based on its actual value, but in the hope that "greater fools" in the future will buy it at a higher price. It's like gambling, where the bet is not on the intrinsic value of the asset, but on finding a "greater fool" to sell it at a high price.
Behavioral finance research shows that when investors overly rely on "greater fools" to take over, market prices may far exceed the true value of the asset. This is like a crazy hot air balloon, filled with infinite expansion of danger. Once there are not enough "greater fools," the balloon will burst, and investors will face huge losses.
In this way, "Greater Fool" trading actually amplifies speculative behavior in the market.
Through "Greater Fool" trading, speculators may temporarily gain high returns, but these returns are often built on risks and bubbles. In this speculative activity hoping for "greater fools," investors may overlook the importance of fundamentals and long-term value, ultimately falling into the vortex of risk.
Behavioral finance believes that investment decisions should be based on in-depth research of the market and assets, rather than blindly relying on finding "greater fools." The theory of "Greater Fool" makes it easier for investors to fall into an overly optimistic mindset, ignoring the risks and uncertainties that may exist in the market.
Therefore, avoiding the temptation of this "Greater Fool" trading is like maintaining a wise course in the sea of investment, relying on thoughtful decisions and rational analysis, rather than relying on luck and hoping for "greater fools." Only through rational investment can we navigate through the waves of the market and stay away from the bottomless pit of collapse.
These are the three trading traps that must be avoided in learning behavioral finance. By avoiding these traps, we can win in long-term trading.
This behavioral finance course ends here! In the first section, we briefly introduced the concept of behavioral finance, and learned terms like "cognitive bias" and "market sentiment"; in the second section, I explained how to use behavioral finance strategies based on irrational decisions; in the third section, you learned four methods to profit during times of panic.
I believe that taking this course will further advance your investment skills!
See you in the next lesson!
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