If you read the editorials and articles in major financial sites or even watched the news on finance, you would think that everyone was a rational trader and quite sophisticated. However, that is not true, according to science. In most cases, human nature plays a huge role in the trading world. Here we will examine what the science says about trading. It might even provide you with some insight into how to improve your trading.
Overconfidence is a Major Issue
In the trading world, about 75% of traders rate themselves as being above average. This is consistent with various scientific studies conducted in the trading world. However, only 50% of traders should have rated themselves above average, according to statistics. Dealers will usually overestimate their abilities and professional success.
When traders have been trading for years, they are likely to realise they are incurring huge losses. Overconfidence is also an issue with lone traders. Those who think their skills are excellent will usually trade more often when they make losses or wins. It has also been shown that overconfidence is an issue for senior traders as well as junior ones.
The other issue that scientists have examined is irrational trading. In theory, irrational traders should be driven out of the market after just a few wrong trades. However, this is not the case. Many irrational traders manage to remain in the market despite making awful decisions. Another interesting observation was on Chinese investors. When they make mistakes, they will usually be reluctant to realize they made mistakes. Besides that, they trade often and tend to have limited diversity.
Investors who were successful Before Online Trading
Those investors that have had successful trading before they began online trading believed they succeeded because of the investment skills. As a result, they will usually be overconfident. Once they go online, they have access to a huge amount of data. This creates the illusion of being knowledgeable. Since they manage trades with just a mouse click, it gives the illusion of control. The sum total of this is overconfidence.
How Technical Analysis Affects Trading
Adding technical analysis to trading can lead to better trading success. With good technical analysis, it has been shown that it can lead to huge returns, especially when working in the foreign exchange market. It is worth noting that there are technical trading rules for the Russell 2000 and the NASDAQ Composite. However, there are no such rules for the S&P 500 and the DJIA. However, it is worth noting that the technical trading profits have declined with time in 12 futures markets.
Big Events Have an Effect on Trading
Stock prices will often rise following a major event before going back to the pre-event levels in five days. When prices reverse, most people will lose about 0.88%. Individual investors have also been shown to make a huge purchase following announcements on huge events.
What it shows is that there is a lot that influences purchase and sell decisions apart from simple rationality. As a result, you need to look at yourself and understand what influences your decision-making to become a better trader.
AudaCity Capital Founder and CEO