Trading Psychology 2 2147

"All economic movements, by their very nature, are motivated by crowd psychology." - Financier Bernard Baruch

Technical analysts use support and resistance to approach the market and it can be established in numerous ways, such as: key highs/lows, trend lines, Fibonacci levels, moving averages, pivots and more. Many new traders tackle to understand the trading support and resistance is often a challenging task. Support occurs where a downtrend is expected to pause, due to a concentration of demand. Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply.

There are many levels, characteristics and skills required to be successful in trading and, to see how the chart performs and how much human psychology intertwined with to determine the direction of stock’s trend. Psychological aspect of trading can be as important as other attributes. Traders don’t need any tools or complicated analysis to find them. These levels are called “Psychological levels.”

Psychological levels:

Psychological level draws a big attention and witness a reaction by price when it is tested. It indicates the price levels and these levels are the whole or round numbers. Round numbers tend to be important for support and resistance levels due to their psychological importance.  People most of time will automatically round to nearest whole number. Whole numbers in trading involve double-zero, for example some whole numbers are 1.2100, 1.2200, 1.2300 etc. Whole or double-zero numbers play a huge role. Massive orders are placed before it reaches whole numbers. Usually, when reaching round-numbers, these levels act as either support or resistance causing a reaction in price to establish new levels.

“Everyone wants minimum risk and maximum return, but it is rarely possible to do both,” – Neil Pedley of Vestra Wealth.

The reason of the behavior of price when it interacts with these levels:

People usually think in round numbers and it is the human tendency to pay special attention to numbers that are “round” in some way. People are more comfortable to start or end a trade in round numbers, which will help them due to the simplicity. This is general psychology of human beings. So when a large number of traders are trying to close their trade when the price reaches a round number, there will be a change in momentum of price. If the price is in uptrend and when more traders are trying to take their profit at a round number level, the price will cease to move up causing a change in direction and it doesn’t really mean the price reversal. Support and resistance levels are psychologically important levels and a lot of buyers and/or sellers are willing to trade the stock. When it breaks, the market psychology shifts and new levels of support and resistance are established.

Trading_Psychology Pic Credits: ROLLNREEL.com

Psychological levels and money management:

There are many important levels to be aware of trade management. When placing stops, we use these whole numbers so that you don’t get stopped out before the price reversals. These stops can massively alter order flow and price changes. It has to be considered while setting profit targets as well. Round numbers are powerful because institutions usually place their orders at those levels.

Conclusion:

Once the psychological levels are understood, traders using the levels can find the entry and exit points, in accordance with appropriate risk parameters. Profitable trading can be achieved, if an individual can master psychological approach and combine it with other factors may potentially be considered with more strength to your trading plan and it can be learned through experience. It just takes time, practice, and the right mindset towards the market.

“Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

Stay tuned to our next post “Philosophy of Making Trading Rules”

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The 5/25 and 80/20 rule 0 43

Warren Buffett as we all know him not only thinks about securities all the time but also spends some valuable time making the world a better place and life easier.

His 5/25 rule originates from an anecdote from one of Warren Buffett’s employees. The story goes like this…

Warren Buffett one day approaches his pilot, after realizing that he had worked for him for the past 10 years. Buffett wanted to discuss his pilot’s career goals and wanted to help him achieve them. “The fact that you’re still working for me, tells me I’m not doing my job” said Buffett. To map out the pilot’s goals, he was asked to conduct a simple exercise by Buffett, it would later go on to change the way he viewed his priorities forever…

The first thing in the exercise was to list out 25 things that the pilot wanted to achieve in the foreseeable future. Secondly he had to arrange them in the order of importance (descending) and circle the top 5. During the exercise, he found out that prioritising his goals were undoubtedly more challenging than listing them. Buffett later asks his pilot :

What are you going to do with the remaining 20 items?

The pilot replies with :

Well the top 5 are my primary focus, but the other 20 come in at a close second.

He goes on…

They are still important so I’ll work on those intermittently as I see fit, as I’m getting through my top 5. They are not as urgent but I still plan to give them dedicated effort.

At this point Buffet’s expression changes a little and responds sternly :

No, you’ve got it wrong. Everything you didn’t circle just became your ‘avoid at all cost’ list. No matter what, these things get no attention from you until you’ve succeeded with your top 5.

Avoid at all cost!? His pilot certainly wasn’t expecting that.

Buffett’s 5/25 rule states the importance of selective focus. There’s more competition for our attention than ever. Choices have never been more abundant than any other time in history and it’s unlikely we’ll be constrained any time soon. In fact, our options are likely only going to expand as we advance further. More the people, more the diversification among them, more the desires, therefore resulting in more choices.

It’s the primary reason why most of us will never reach the level of competency needed to reap the rewards of being a superstar like Warren Buffett himself. Each time we pursue a new course of action, we incur an opportunity cost. It takes our time and attention away from the things that are most important to us. Your odds of success improve when you direct your focus into a singular pursuit. You have to double down on a few things and rack up the hours trying to get really good at that. The 5/25 rule is another example of how simplicity makes life better and easier. Warren Buffett doesn’t mean to say that you have to lead a boring life doing the same thing over and over again. Once you have mastered the 5 circled goals, move on to number 6 and beyond but mastering your tasks could take years and needs all the effort and concentration, because we spend time on these only during our free time and we all have other commitments which are out of our control.

If all of us were asked to do the same exercise as his pilot was, most of us would struggle. The result is that we have a list of items that will almost never get completed. This list only weighs on our mind, and fills us with stress, guilt and overwhelm. It’s a result of the ‘any benefit’ mindset. If you observe carefully, you would realize that you put some things on your list of 25 only because you believe you’re going to benefit something from learning or mastering it and not actually because you want to do it. It is that feeling where you believe you can do a lot more things at once than you actually can concentrate on and feel like “If I learnt how to play a guitar, I could participate on stage events and become popular”, when that’s not what you actually want to do. You add those extra goals in that list of 25 only because you feel a dopamine hit.

Pareto’s principle, popularly known as the 80/20 rule tells us that the majority of outcomes are driven by a small number of things that we do. Chances are that anything that falls outside your top 5 will have little impact on your life. Rather than add on, take the time to eliminate.

Time and attention are two of the most finite resources. There will always be more good opportunities than we realistically have time for. We shouldn’t pounce on every one of them, because not all will be right for us. It doesn’t matter how good an opportunity is if all it does is advance goal number 25 for us. If we force ourselves to eliminate options, we would find that only a few things truely matter to us. We would be better served if we ignore distractions and do more of what really matters.

Use the ‘Pomodoro technique’ to shut down all external distractions. The pomodoro technique involves concentrating for a short time span separated by shorter breaks. Break down your work intervals into 25 minutes separated by a 5 minute break and after every 4 sessions, take a longer break. Ideally 10–12 sessions a day could help you master almost anything within 6 months – 1 year.

Another place where most of us fail is during the dip in the transition cycle

When we experience the opportunity to learn something new, we enter into what’s called the ‘Honeymoon phase’. This is where we experience releases of dopamine as we experience new things, we’re hardwired to appreciate and seek out novelty because it makes us feel good. Once the ‘Honeymoon phase’ is over we experience the dip and our progress begins to plateau or diminish and this is when most of us quit. If you can predict the dip is coming when you’re learning something new it’s easier to fight through it because you know the dip exists and it only lasts temporarily.

Vilfredo Pareto, an Italian economist found that 80% of the land in Italy was owned by 20% of the population. This 80/20 distribution became popular for occurring over and over again in many scenarios. For example, about 20% of the world’s population control about 80% of the world’s income. The 80/20 rule by Pareto is the same as Buffett’s 5/25 rule (5 is 20% of 25). You could infact verify it with your own daily life events, you would approximately wear only 20% of the clothes in your wardrobe 80% of the time, if you were to have 5 shoes, you would wear only 1 of them 80% of the time. About 20% of a business’s clients account for 80% of their revenue. This might not always be the case though (but it predominantly is), that being said one can use this to analyze your life and optimize it. For an example, if you have an exam tomorrow but decide to start only the night before. Say you have 10 topics for the exam, pick the 2 topics that would maximize your result, meaning spend time on learning that 20% of your syllabus to earn 80% of the marks. You can use the remaining time, if you have any, to learn the remaining 80% of the syllabus that would fetch you only 20% of the marks, you at least get the important things out of the way and have managed to maximize your result in a minimum time frame.

The Pareto’s principle gave rise to one of my most personal favorite papers to have ever been published. It refers to the phenomenon as ‘The champagne glass effect’.

The paper goes on to explain with deep picturization on how the champagne glass represents the 80/20 rule and how the bowl on top represents the top 20% of the people who have a part of 80% and the rest 80% of the glass, the stem supporting the bowl’s weight with less than 20% of it’s entire weight.

Hope the answer helped you and gave you an insight. Peace 🙂

 

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