In financial markets, the concept of “psychology of the crowd” implies the same behavior of all market participants in specific situations. That is if the majority of speculators goes into sales, the so-called “slave traders”, whatever is their decision up to the reporting moment, will also repeat the actions of the majority. And at the same time few people think if the crowd’s decision is correct. Perhaps “herd opinion” simply worked, when only a few people made a decision, and the rest rashly followed them.
The concept of psychology of the crowd
In real life, a person believes that acting together, rather than alone, is much more comfortable. A similar situation occurs in the foreign exchange market - it seems like it’s not so scary when acting together. But does comfort always justify the end result? After all, no one guarantees that the majority opinion is the only true one.
Why are we so attracted to the crowd?
Alexander Elder, a professional trader and expert in the Forex trading, noted that, being in a group, people automatically start to think the same and act differently than if they remained on their own. Trading area is no exception. But why is this happening?
There are no secret reasons for this. Everything, as in ordinary life, judge for yourself.
Firstly, a person always needs someone who will tell them how to be and what to do. Well, it’s difficult to act alone, anyway. And if this is a group of people, then without a leader there is no way at all. And what it will turn out to be is a secondary question. Therefore, even “lone wolves” join a bunch of active traders, hoping that the leader certainly is not stupid, since so many people trust him.
Secondly, laziness. Yes, it is inherent in some traders too. Reluctance to spend time on technical and fundamental analysis, which can result in a good forecast for the future, makes the trader look around and “spy” on how the majority behaves.
Thirdly, greed. Contrary to logic and a well-formed forecast, traders often turn their backs on their own judgments and follow the crowd. Yes, following their principles, which are based on their own analysis, it is quite possible to achieve results. But will they be as attractive as if you follow the crowd? Not for nothing that the majority acts the same way - it is unlikely that only fools gathered there. This is a typical opinion of traders who succumbed to passion and thirst for quick profit.
Pros and cons of psychology of the crowd
The crowd, in principle, has only one advantage - you seem to be protected, because you are not alone. It is not so painful and unpleasant to withstand blows and Forex is no exception. Gone in the red is unpleasant, but you are not the only one. You can safely shove everything onto the very leader who led everyone, and not to blame yourself.
But let's be honest - the disadvantages of this technique when working in the foreign exchange market are much more significant than the feeling of security when following the crowd.
As practice shows, the crowd simply cannot predict the trend reversal in the foreign exchange market. It’s okay to move in the direction of the crowd during the intensive growth of the price of an asset, but only if this does not contradict the analysis of the trader, which he should never neglect. Furthermore, it all depends on the situation. The value of an asset cannot move in one direction forever, and as soon as the price level does not have enough forces to continue its movement, it will go in the opposite direction. When will this happen? It depends on the same crowd. Only an independent trader can change his course during kickbacks without waiting for the “herd”, thereby protecting himself from fatal errors.
There are three main obstacles that origin from the “herd opinion” in the Forex market:
- fear;
- false security;
- ignoring the trading plan.
Let us dwell on each of these points in more detail.
- Let's start with fear. Uncertainty that the decision made in the course of an independent analysis will turn out to be incorrect in the end - the phenomenon is quite common. Especially among novice traders who do not yet have well-developed strategies and market sense as such. However, not only the fear of going the wrong way sometimes controls the trader, but the fear of earning less than we would like. Yes, we are talking about the greed.
- False security. We have already noted a little higher that in the crowd, people, including traders, feel much more secure than alone, in particular, if there is no clear plan and strategy developed. It remains only to follow those who are supposedly wiser and possibly make the right decision. A trader potentially seeks support for his decision and, if he does not find it, he gives up and follows the majority.
- Ignoring the trading plan. Another case of a tough mistake, when the trader has conducted analysis, made the forecast and the decision-making plan was outlined in the very near future, and from a logical point of view, everything seems pretty rosy. If it were not for the doubts of the trader, who, seeing how the majority acts in the opposite direction, is simply misleaded. In this case, the built plan goes downhill and, more recently, an independent trader confident in its abilities, adjoins the crowd.
How to avoid following the psychology of the crowd?
They will be confusing: both in life and in the foreign exchange market traders are united in “heaps”. What to do in order not to follow them and stick to your own plan and decisions? We’ll give advice.
Before starting trading, first of all, one should calm down morally. Even despite the fact that there are no visible reasons for concern and, in principle, the trader feels ready to rush into battle, the emotional background can be unstable. This is what the so-called reference point is needed for, which will serve as the start of trading without stress, nerves, fatigue and anxiety. A cold head is the only thing a trader should have in order to get profit.
Take profit
A trader of course must have a clearly defined trading plan. Without it, trading turns into a game where the situation takes control of a happy event. Of course, not all professional traders were born geniuses, and their successful trading was preceded by a long and sometimes thorny path. Therefore, choosing this path, beginners should be prepared not only for hard work, but also for the ability to cope with any obstacles, which include the crowd.
Trade against the crowd
Many strategies have been built on market sentiment, and some of them are really based on work against public opinion. But this does not mean at all that the essence of such strategies is completely opposite actions to those of the crowd. On the contrary, trading is usually conducted in the direction as the crowd’s, but only up to a certain point. The main thing is to get off in time. In this case, the trader must adhere to a number of rules and each of the strategies defines them individually. It is important to realize that nothing, including the value of an asset, can constantly grow or, on the contrary, fall.
Despite the fact that there are several strategies based on the movement against the crowd, there are a number of rules that are taken into account in each of them.
When analyzing the tool, you should use charts of at least 1 hour. The optimal will be a 4-hour timeframe.
- It is recommended to refrain from trading in the accumulation phase.
- Short-term freezing of the asset price should be ignored altogether.
- Do not fix the price until the phase changes.
- It is not worth ignoring the setting of Take Profit, especially if there is no way to observe the market in real time.
The fight against greed, correctly conducted analysis and a clear plan - this is what will help get rid of the herd opinion and eventually subjugate the crowd. Not globally, of course, but psychologically certainly will let you get rid of the need for "public approval".