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All traders are human beings (remember that there is still no robot capable of achieving consistent results in trading). As a result, human psychology plays a fundamental role in financial markets, be it securities, bonds, currencies or commodities.
Economic cycles, which correspond to periods of rising and falling prices, vary in nature. Some of these may be attributable to market psychology. Here's how it works. When an increasing number of people enter a certain market with a long position, as happened for Bitcoin in 2017 or with the IT sector in the late 90s, the price seems to be destined to increase without suffering any setbacks . Consequently, the illusion of indefinite growth is created. What happens next is a real form of hysteria. In the 1990s, many internationally renowned investment experts defined the IT sector as "the only sector that deserves our money". The same happened with Bitcoin just a year ago. When the price of a given asset shows three-figure gains, in the eyes of some experts it instantly becomes the holy grail of trading. In reality it is exactly the opposite. The faster the growth, the greater the probability of a sudden collapse. Bitcoin and the dot-com bubble are no exception. Diversifying the portfolio, therefore, remains the wisest choice.
When the price of an asset (whether it is a stock, a commodity, a cryptocurrency or something else) moves away too much from its intrinsic price – or, to put it in other words, from its real price – the countdown begins. Sooner or later the market will show that the growth potential has been exhausted and the wisest will start to withdraw their investments.
The rise and fall of Bitcoin is a perfect example of the most commonly observed psychological models
The same applies to periods of economic decline. The general public (who is largely responsible for the phenomenon of market psychology) is conquered by the urge to sell as soon as the price starts to fall. What represents an opportunity to buy at a reduced price for a professional, will become a bloodbath for less experienced traders.
It's hard to resist the temptation to keep a profitable position just a little longer, and obviously it's not advisable to close all long positions at once. However, it is important to be able to estimate future growth prospects. By estimating the market price and the levels of support and resistance you can get a better idea of how much momentum the asset you are trading on is still available.
The same logic applies to short time intervals, since most of the indicators take into account the principles of mass psychology. What rises is destined to go down, and what comes down will go up again. By predicting market sentiment, you will be able to predict the behavior of other traders and, therefore, the price of an asset. It might seem trivial, but to be successful in trading, you need to understand how other people think and predict their actions. And this is where the psychology of the market comes into play …
This article does not represent an investment advice. Any reference to past movements or price levels is informative and based on external analyzes, we do not provide any guarantee that such movements or levels may reoccur in the future. In accordance with the requirements set by the European Securities and Markets Authority (ESMA), trading with binary and digital options is only available to customers categorized as professional clients.
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Source: IQOption blog 2018-10-16 14:53:05