Chapter

25

Investor psychology 

L e a r nIn g O b j eCtIv e s

After studying this chapter, you should be able to:

■ Understand how trends and market tops and bottoms develop with respect to various

psychological and emotional biases

■ Identify the behavioral elements associated with trending action and the underlying

reasons for why trends tend to persist

■ Identify the behavioral elements associated with consolidations and the underlying

mechanisms responsible for ranging action and breakouts

■ Identify the behavioral elements associated with market reversals and the underlying

reasons for irrationality at tops and bottoms

t

he study of trader and investor psychology is critical to a full understanding

of market action. In this chapter, we will look at the various behavioral ele-

ments and mechanisms that are responsible for the manifestation of trend action,

consolidations, and market reversals.

25.1 General Behavioral Aspects

psychology, emotions, and Investment Decisions

It is a well‐accepted fact that the market is driven by expectations. In other words,

the market is driven by the expectation of future prices. Expectation itself is a

consequence of various beliefs, biases, habits, knowledge, attitudes, and emotions.

Fear, greed, and hope play a very large part in trading and investing. Peer pressure

and other third‐party influence may also affect investment decisions. Experiencing

significant life events is another factor that may alter one’s outlook and invest-

ment perspective. For every 20 good reasons, there are 20 other reasons why one