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Following the Crowd

Do you ever feel as if you are just going through the motions, acting without thinking? Are you surprised that you react emotionally, selling prematurely when you meant to hold out a little longer? Or do you jump into a trade too soon, before you have systematically thought out your trading plan? You may be giving into a natural inclination to follow the crowd. It may seem routine, but if you aren't fully conscious of your actions, you may find yourself giving back profits.

The trading and investing public often act like a herd of cattle. This is a popular trading analogy, but humans are quite different from a herd. Have you ever closely studied a herd of cattle? Cows aren't the brightest animals. They can be contained easily with a fence of thin barbed wire, and it's easy to sneak up on them and tip them over. When one cow decides the grass is greener at the other side of the pasture, the herd just follows for no good reason. It's instinctive. Cows are "programmed" by nature to follow each other. They don't seem to think at all. By banding together, though, they can feel safe. There is safety in numbers.

Sometimes the public who invest in the markets also seem to act without thinking. Again, there is safety in numbers, and the masses feel most comfortable when following the crowd. They search for confirmation and try to do whatever is most popular. For example, it is common to see the masses react too quickly to media reports. When a commentator reports that a company has missed an analyst's estimate, masses of traders start selling as soon as possible, regardless of the underlying dynamics behind the overall trend. When a stock is talked up, even if the information is based on unfounded rumors, the masses start buying. Fear and greed drive many traders to execute trades on a whim, but if you want to be a winning trader, it is vital that you base your trades on a trading plan.

Unless you are a scalper, trading quickly and automatically isn't a very good strategy. It's much better to develop a realistic trading plan, and execute it consciously and deliberately. It's vital that you have a reasonable hypothesis as to how the market should move according to your plan, and also some hunch as to why the market is moving, or going to move, in a particular way. You should spend some time making sure when to enter, when to exit, and you should have a clear sense of what should happen and when. When you go to execute a trade, you may not need to be scrupulously deliberate, but that depends on your experience. If you have a vast amount of experience, you can quickly process a host of information and work from an "intuitive" feel you have about the markets; but if you are a novice trader, it's usually necessary to be a little more careful. Pay close attention to what the markets are doing, and follow your trading plan.

The conscientious trader has a trading plan, and follows it. Impulsive traders make it all up as they go along and "trade by the seat of their pants." If you are an extremely seasoned trader, trading on automatic pilot can work, but if you are a novice trader, you are likely to make trading errors. You may give into emotions of fear, greed, hope, or regret. When you let your emotions guide you, however, you'll tend to act as the masses do; and when you trade like an unconscious member of the herd, you'll end up with losses.

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Sunday, 26 May 2024

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