What does it take for someone to become a professional trader? Is it only capital? No. Behavioral finance. Is it trading style or a secret trading strategy? Well, you might be surprised to find out that the answer is neither one of these. The answer is actually inside of your mind. The mindset of a trader is what makes him or her a professional trader.
In this article we are going to focus on a phenomenon known as behavioral finance, and in this way take a peek behind the curtain of the psychology of being a trader. We are also going to discuss the behavior of traders, the pitfalls that you need to be aware of, and some ways you can develop your own behavior as a participant in the financial world. So stick around as we go beyond the veil of a trader’s mind.
What Is the Definition of Behavioral Finance?
In simple terms, behavioral finance is a field of study whereby we can study and understand the role of psychology in trading and in all financial matters alike. Basically it studies what role your personality or your character as a market participant can play, and whether it is to your advantage or ultimately to your disadvantage.
Similarly, the field of behavioral finance can help us understand what steps and methods can help you develop your own behavior and personality as a trader or investor and thus be able to make better and hopefully more profitable decisions in the market.
It also helps us find out the pitfalls that are common with wrong behavior in the financial world. In this way we are able to monitor our own behavior with regard to our finances and fix wherever we need more improvement and betterment.
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Why Is Behavior Important in Finances?
The reason we consider behavior as an important part of the financial world can be seen in the most important part of any market – i.e. the participants themselves.
Any market or financial venue is defined by the people who partake in it. Without the participants there would be no forex market, or stock market, or crypto market, or any other financial market left in the world.
And when we examine the participants in the market, we can see that the most important factors in their decision making processes are their mindset and their personality.
This is why for centuries, economists and market analysis have given so much importance and weight to the mindset and emotions of people who engage with different markets.
You might see prices and figures on the face of it. But behind all the numbers and digits, we see nothing but the decisions that are made by market participants.
In fact, there are many schools of economy that consider the emotions of traders as the most important force that moves the market and causes price changes and price movements.
This is why it is vital to understand the field of behavioral finance and thus be able to use it to your advantage in any and all of your financial decisions. So let’s take a look at the common behavioral biases and also the ways you can improve upon your own financial behavior in order to avoid those biases.
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What Is the Most Important Behavioral Bias in Finances?
There are many issues that can be categorized as psychological or behavioral mistakes that market participants make during their decision making process. We want to discuss some of the most salient of them.
- Short-sighted behavior: one of the most important behavioral biases can be called being short-sighted. But not with your vision, but with your behavior. You need to be able to see the bigger picture at all times and have a long perspective of the market. Most of the time, investments and trading decisions take time to pay off. If you are short-sighted and only see the short frame time period, then it can cause damage in your decision making process. Always make sure to take a look at things in the long time frame. It doesn’t matter which market you are active in, it can be the forex market or even the real estate market. In either case, you need to train your behavior to be able to see the big picture stuff.
- Dollar-driven behavior: another bias that is usually seen among people in all financial markets is that they have a dollar-driven behavior. This means they look at the dollar value and the dollar amount when they should in fact be looking at the percentages. This is a hugely and vastly important bias because it can cause you to make wrong decisions all the time. It doesn’t matter whether we are discussing profits or losses. In both terms, thinking of them with regard to their dollar value is wrong. As we said, you should instead train your behavior to think about all of these events in percentages.
You should read: A few steps to creating a professional trading personality
Conclusion
Behavioral finance is a field of study that allows us to research the psychology of market participants and people who are active in financial markets. In this way we are able to understand what goes wrong in the decision making process of traders and investors. This is because the emotions and behavior of traders are the most important factors that define the outcome of price movements and price fluctuations in any market. How traders and investors feel about an asset or financial instrument will ultimately translate onto the chart. In this article we discussed the notion of behavioral finance and the common biases involved in it and the way you can avoid them.
