HH The Market Cycles: Fear And Greed

Financial Markets go through different cycles that produce different psychological effects on those that choose to participate. At market peaks of an investment cycle, traders and investors feel satisfied about the returns they’ve realized and believe that the favorable market environment will remain in place for an extended period of time. In other words, they become complacent and tend to dismiss any red flags that begin to emerge. This good feeling is usually followed by a sense of nervousness when the markets slowly start turning lower.

Unfortunately, this occurrence is the result of those traders and investors not having a plan in place to properly manage risk, thus they are subject to their emotions. Moreover, they also don’t have a strategy that helps them time the markets, meaning they don’t know when to get in (buy low) and get out (sell high). As you might imagine, this poses a big challenge for inexperienced traders and investors.

In order to deal with some of these challenges, a trader/investor must understand the various stages of trading psychology.

Stock market cycles and fear and greed

Stages of Trading Psychology

Emotional Stages of an Up Trend in the Market

Optimism

Traders experience optimism when the market has been in a sustained uptrend for several months and the prospects for earnings and the economy are in the recovery phase. In this stage of the market traders feel comfortable buying as they see little reason to not put some money into the market because they perceive risk to be low. As the market continues higher, optimism turns into excitement as early buyers are starting to garner nice profits and every pullback is seen as another buying opportunity. In this phase, buyers are rewarded for purchasing every pullback, and like Pavlov’s dog, will continue until they are no longer rewarded for their actions.

Enthusiasm & Exuberance

As the market accelerates to the upside the thrill phase begins. Enthusiasm sets in as profits increase substantially, transitioning to exuberance as investor confidence goes through the roof.

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