Why Traders Average when market moves against them ?

Psychology is one of the basic components of technical analysis along with mathematics and geometry. Psychology is a subject that best helps us understand human nature and emotions. It helps us to know why people feel, think and act the way they do. One of the main reason why technical analysis works is that human nature and emotions remain the same irrespective of era one is in. People were greedy and fearful even a hundred years back as much as they are now.

The stock market may not have emotions, but as a person, you do. To attain and maintain a sustainable and long-term career as a trader, it’s incredibly important to cultivate a mindset where you can stay calm during trades and avoid succumbing to emotional reactions.

Trading psychology is as important as other attributes such as knowledge, experience and skill in determining trading success. While trading emotions often clouds our decision-making. And it is very difficult to conquer our inherent emotional biases. But we can understand the range of emotions we may experience as a trader and how it affects our interaction with the stock markets. Greed, fear, hope, euphoria, panic among others are the range of emotional biases that every trader comes across while trading. To be successful trader we need to keep these emotions in check.

We educate are our readers about such emotional biases and help them conquer these emotions to become a successful trader.

Eric Barker has a new article (link here) on how to win every argument. The article had a point which made me think whether the same situation happens in trading.

So it quoted an experiment by psychologist Drew Westen, which showed to supporters, footage of their favorite candidates completely contradicting himself. The experiment found that as soon as the people realized that the information contradicted their world view, the parts of the brain that handle reason and logic went dormant, while the parts of the brain that handle hostile attacks – the fight-or-flight response – lit up. Essentially logic gets thrown out the window, and it just becomes a fight where you do anything to win.

A similar situation occurs in trading, when you have a certain expectation of how the market should behave. E.g. you might for various reasons, think that the market will go up. So when the market does not follow what you expect, you might initially make up excuses for it. However when the market continues to go completely in the opposite direction of what you expect, your logic and reasoning centers would shut down, your fight-or-flight response kicks in, you treat it like a hostile attack on you, and you would do anything to win (or not lose), e.g. keep averaging down. I’m sure this sequence of events led to many traders blowing up their accounts. It is pretty interesting that the experiment showed this as a ‘natural expected’ behavior.

As always, trade what you see, not what you think. 

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