the hAndbook of technIcAl AnAlysIstraders will also start to display overconfidence, believing that the trend will never
end. As the market and their unrealized profit rise, greed will begin to surface
in the form of profit reinvestment. Overconfidence is also one of the underlying
causes for increasing margin debt.
As the trend matures, traders begin to display irrationality by adopting and
adapting to the behavior of other participants who are all caught up buying into
a rising market. Such participation is not based on research or sound advice but
rather on mimicking the action of others. As buying pressure increases, this forces
price to rise even higher, and as prices rise higher, this attracts even more partici-
pants to buy into the market. This creates a positive feedback cycle or loop that
causes prices to spiral up in a frenzy of reckless buying. The traders are said to
be in a state of irrational exuberance, a phrase first used by Alan Greenspan and
made popular by Robert J. Schiller’s book of the same title. As the top approaches,
the market is at its most bullish state, culminating in a blow‐off or buying climax.
Market bottoms
Market bottoms are accompanied by extreme states of panic and fear, with par-
ticipants selling at any price available. The market will be at its most bearish and
culminates in a selling climax. As the market starts to rebound to the upside,
cognitive dissonance begins to build as most participants are still under the psy-
chological and emotional influence of representativeness bias, believing that the
market will decline further. They are still influenced by the recent decline, a view
that is anchored by declining prices.
Cognitive Dissonance at Market tops and bottoms
Once the top is formed and price starts to exhibit bearishness, the amount of
cognitive dissonance begins to build. The greatest amount of dissonance is experi-
enced during the early stages of a top or bottom reversal. See Figure 25.5.
As we learned earlier, when traders experience dissonance, they will attempt
to reduce their discomfort by:
■ (^) Ignoring or downplaying the problem (compartmentalization bias, loss aver-
sion bias)
■ (^) Selectively exposing themselves only to information that conforms to or agrees
with their current view of the markets (selective exposure bias)
■ (^) Misinterpreting the information in such a way so as to make it conform to
their current view of the markets (misrepresentation bias)
■ (^) Being ego defensive and investing even more as the trend moves against their
positions (sunk cost bias)
■ (^) Blaming the problem or loss on others
As such, when the market begins to turn, traders experiencing representativeness
bias will attempt to maintain their view that the trend is still in effect in the face of
contradictory information or evidence. They may react by either being ego defen-
sive and sinking more capital into the market or rationalizing away the issues via