Greed and Fear - Daily trading signals based on mathematics and software, no opinion, no emotion, no ego.

roulette1Everybody knows this feeling and also knows it is a false feeling. You're in a casino, and the roulette hits red. Then again and again. After three, four maybe five times red in a row, you start to think it's time for the roulette to hit black. Now, in this simple case, you know that's not true.

The roulette has no memory and we assume it's fair. So every round offers an equal chance for red and black (as well as green, 0, the casino takes it all). So the roulette may hit red 20 times in a row. The chance of that happening is very small, but once it has reached 19 times in a row, going from 19 to 20 is just as likely as going from 1 to 2 times red in a row.

Although we know this, our brain doesn't feel comfortable accepting it. If you had to write down a random sequence of 'red' and 'black', it would probably not be as random as the roulette. Our brain is a bad randomizer, it wants the sequence to look 'realistic' and 'fair'.

Now look at the markets where things are only a bit different. Unlike the roulette, the market has a memory. That market-memory determines where a feeling of greed pushes the feeling of fear away or vice versa. In between major greed/fear moments, there are up and down days. When we look at several up days in a row, a trader may expect a down day very soon simply because the market went up too many days in a row. This is our brain saying it's 'not fair and not realistic'. The brain wants the up and down days to be more alternating to make it 'more realistic'. What this hypothetical trader is trying to do is go short in strong uptrending market. Not good for your trading account.

Recommended reading:

Lizards and pigeons: Science of irrationality