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The hot hand fallacy in trading is a cognitive bias that occurs when traders believe that a winning streak will continue, even though the probability of success remains unchanged. In other words, traders may believe that because they have experienced a series of successful trades, they are more likely to continue to make successful trades in the future.
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.... that you are thinking that he is thinking? This is the funny paradox that is a big factor in the financial markets. In 'A mathematician plays the stock market' by John Allen Paulos, the author analyzes where this is going and what it means.
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Oftentimes, traders feel that the market is full of opponents called 'they'. Traders have the feeling that 'they' (these opponents) are out there to get them. 'They' are pushing the market higher after which 'they' will let it drop. 'They' will hit your stop loss and then 'they' will steal your money. Usually 'they' are the banks, the big funds that can really move the markets. In other words: The Evil. And what 'they' are trying to do is always so obvious, it's almost a crime.
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We like to think that humans make decisions in a rational and logical way like computers do. Most economists model the consumer as a rational being, a consumer that makes well-informed rational decisions.
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Frustration among traders is very common when they go short on anticipation of bad economic data (or long on good economic data). This is due to the fact that in many cases the market does not always come down on bad economic data, or vice versa does not always rise on good economic data. Bad is good sometimes, and good is bad. Traders are frustrated because the market is not doing what they think it is 'supposed to do'.
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We have discussed this issue multiple times before. When you are trading, you have to let go of your ego. This also applies to the kind of news a trader reads or the kind of chat rooms and forums the trader is taking part in. There are websites that always bring bullish news and opinions. There are others that are always bearish. Most often this is not high-quality journalism, but more like someone with a loud voice claiming all sorts of things.
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Everybody 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.
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When I think about trading rules, the first thing that comes to mind in less than 0,047 seconds is: always to use a stop loss. Everyone knows this saying 'Cut your losses and let your profits run'. That is, of course, easier said than done and this article is not about that. This article is essentially about accepting a loss.
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Before taking a trade, you should have done your analysis. If the analysis shows that the trade has a high probability of being successful, you enter it and see what happens. Now suppose the market moves away and your position is getting worse. No real problem, there is never any guarantee the analysis will work.
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Some say in trading the true character of a person comes forward with all its strengths and weaknesses. Suppose a trader has a tendency to be perfect, to perform each and every little task in perfection. For people with perfectionism, it may not be that hard to function in everyday life, maybe with a little struggle here and there. But it's very hard to combine perfectionism with trading.
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In this article, I would like to discuss the subject of overconfidence. Maybe in some way, overconfidence can be looked at as the exact opposite of perfectionism. Neither emotions serve a trader well as they do not take the market (movement) for what it really is.
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Many traders read all the news, rumors, and gossip they can get their hands on. And there's always more to read. Then they start convincing each other on chat forums that the market has to go in a certain direction based on that news. In the end, they all agree, but we know what happens with crowd consensus.... it's not going to happen.
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We have all heard of the famous experiment by the Russian physiologist Ivan Pavlov where dogs have been conditioned to expect food following a particular event. The Pavlov dogs have experienced the same sequence of events so often, at some point they know what's coming next without really thinking about it. They start to show emotions 'in advance', and salivate even before their food is served. This is one form of conditioning.
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It's been over a year now since we've witnessed the so-called flash crash. On May 6th, 2010, within minutes the markets dropped several percent, then bounced and recovered a large part of the losses. To relive those exciting moments, here are some video clips. If you know of any other clip that should be here, please send me an email. This post with video clips is mostly fun, but it's also showing us panic, anxiety, greed, and fear. Besides crash flash videos, there are some other clips that show the emotions that sometimes come with trading.