Read about what crowd psychology is and how it can make you rich, or completely wipe you out.

The market is a gigantic crowd whose members bet that prices will rise or fall. All bets are what traders think the future mood of the crowd will be. The mood of the crowd swings back and forth from hope to fear. The value of your investment depends on total strangers.

People change when they join crowds. They become more impulsive, search for a leader, and are more likely to react to emotion rather their own individual intellect. Institutional analyst reports and research reports are attempts by bankers and their clients to assert themselves as the group leader in as many crowd members minds as possible.

In studies done in the 1950’s by psychologists, an individual can tell which of two lines is shorter on a piece of paper; however, when he becomes a member of the crowd, he loses that ability when put into a group whose members purposely give the wrong answer! This isn’t a guy with low IQ either. These were college graduates who were swayed by the opinion of the crowd!

In other studies, it was discovered that group members believe other group members and group leaders more than they believe themselves. According to Sigmund Freud, groups are held together by their loyalty to the leader. The feeling group members have towards group leaders stem from our childhood feelings toward our fathers, feelings such as: trust, fear, the desire for approval, and rebellion. When we join groups, our thinking regresses to the level of a child. A leaderless group cannot hold itself together and so it falls apart. This explains buying and selling panics. When traders feel that the trend they have been falling has abandoned them, they sell their positions in panic.

When you join a group, you act like a child following a parent. The market does not care about your well being. Do not look at the market as your parent. Successful traders are independent thinkers.

Group loyalty is essential in the military. Joining a group called a union can help you get paid more at your job. Joining a political group can help change the world in the way you want it. But no group can help or protect you in the market.

I am often asked by new traders why the market reversed and went back up immediately after they dumped their losing position. This happens because crowd members are feeling the same fear causing everyone to sell their shares at the same time. Once all the sellers are out, the market has nowhere to go but up as optimism returns to the market and the greed fear cycle starts over again.

Don’t argue with the crowd. If the crowd turns against you, sell your position and run. Your only focus should be to decide when to join the crowd, and when to leave.

You must base your trades on a trading plan. You then need to stay disciplined by executing on your trading plan. Base your trades on your trading plan and not jumping in response to changes in price. It may help you to write down your trading plan. You need to know exactly what your profit thesis is, and what your entry and exit points are. Do not make decisions based on spur of the moment feelings as a member of the crowd.

You will only succeed in trading when you can think and act as an individual, using a disciplined trading strategy. The weakest part of any trading system is the trader himself. Traders are slaughtered when they trade without a plan or on feelings. It is usually never a good idea to deviate from your original trading plan. You do your best thinking before you join the crowd and have money at stake. You must observe yourself and notice changes in your mental state as you trade. Write down your profit thesis and your entry and exit points. You must not change your plan while you have an open position.

I hope you enjoyed this article and please feel free to leave your comments below. Thank you and happy improved trading.

Lance Jepsen
President, GuerillaStockTrading.com
Your Trading Coach
(because everyone, even Tiger Woods, needs a coach)