Investor Psychology
make irrational decisions in order to remedy the situation. It is part of a larger
classification of behavior referred to as loss‐aversion bias.Mental Framing and anchors
As the trend unfolds, it starts to become obvious. This representation of a trend
frames the mind, and all subsequent opinions, technical references, and thought
patterns will tend to revolve around this mental frame. For example, traders tend
to focus on buying at support, peaks, and higher prices in an uptrend. This men-
tal frame is anchored by rising prices and the appearance of higher peaks and
troughs. Once a trader is influenced by this mental frame of a trend in effect,
which is anchored by elements associated with the representation, all subsequent
decisions and actions tend to be trend promoting. There is a tendency to preserve
the status quo. In short, the appearance of an uptrend will tend to cause more
bullish‐based or ‐biased decisions. The reverse is true for downtrends. We may
refer to this effect of framing and anchoring as representativeness bias.
There are a couple more common behavioral biases that may account for
trend persistence that are based on cognitive dissonance. As mentioned earlier,
some traders resort to selectively exposing themselves only to information that
conforms to their current expectations and opinions of the market. As a conse-
quence, traders and investors tend to downplay and ignore bearish signals in an
uptrend. Such behavior is trend promoting. Another common form of behavioral
bias is the misinterpretation of data in such a way as to corroborate the trader’s
current view of the markets. One common example is the misinterpretation of
a major reversal as a mere correction of the existing trend. We may refer to this
form of bias as misinterpretation bias.
It is also human nature to be overly invested or influenced not only by our
own decisions and beliefs, but also by those that conform to our view of the
markets. Hence, once a decision is made, there is a tendency to maintain a certain
view rather than change it. This form of bias is referred to as confirmatory bias.
Hence once a trader has decided that the current uptrend is strong and reliable,
he or she will be more likely to rely and maintain such a view rather than react to
other views. As before, such behavior is trend promoting.
Many traders are also influenced by the behavior and attitude of others. In an
uptrend, many traders go long not because of the conclusions reached by indepen-
dent analysis or research, but rather because other traders and investors are going
long. Trade decisions are based on the actions of others, rather than on analysis
and information. Many traders also adopt the attitudes of other traders. Such be-
havior may explain the rapid movements in price during a trend.
Overconfidence is also responsible for trend persistence in the markets. It is
not difficult for traders and investors to profit in an uptrend. But many traders
and investors prefer to believe that it is their methodology that is responsible for
their recent profitability. The more profit is made, the more likely that traders will
be confident with their trading and investing methodology or approach. In many
situations, it leads to a state of overconfidence. Such behavior or attitude is trend
promoting, that is, it is bullish for uptrends and bearish for downtrends.