Psychological Mistake #3: Following The Opinions Of The Majority

There is a lot of overwhelming evidence that suggests that humans have a tendency of becoming less rational when placed under the influence of collective psychology. This is why charismatic speakers like Hitler could induce the masses to subscribe to his beliefs. This is also why many investors and traders in the financial markets are naturally under the influence of herding instincts which cause them to gravitate towards extremes in market sentiment, leading most people to buy near highs and sell near lows, and therefore lose money in the markets.

Such instincts are rooted in the sense of security that we tend to find when we belong to the majority. In the field of psychology, there have been certain experiments where we clearly see that most people tend to act against reason when they are under the pressure of the of the majority. Such a behavioural phenomenon is especially harmful to our success in trading the Forex market.

In is natural to feel uncomfortable about being in the minority. However, we need to overcome such a tendency if we want to stand out among most investors and traders in the market. In the Forex market, if you do what everybody else is doing, then you are likely to get what everybody else gets. This means that you are most likely going to buy near the highs and sell near the lows, and cut your profits short and allow your losses to run.

How many times have we realized that when the majority agrees on a certain course of action in the market, it is the time when we should stay away from that course of action? When the market trends upwards very strongly, most people are likely going to enter long positions near the top of the trend. Similarly, when a strong downward trend happens for a sustained period of time, most people will enter short positions near the bottom of the trend. The underlying psychology is that it feels most comfortable to enter a trade when most people agree with it, and most people will agree on a certain course of action when it seems clearest to everyone that a strong trend has lasted for quite some time.

Writer Ben Hecht once said, "Trying to determine what is going on in the world by reading newspapers is like trying to tell the time by watching the second hand of a clock". This is an extremely enlightening quote that aptly reminds us that public opinions will not, in the long run, help us make wise investing and trading decisions. We also commonly hear traders saying that "the trend is your friend". However, this statement is often being misinterpreted.

As stated earlier, a trend becomes clearest to most traders and investors after it has lasted for some time and is coming to an end soon. As a result, most traders and investors are psychologically driven to buy near the top of an uptrend and sell near the bottom of a downtrend. Most people find safety in herding behaviour, i.e. what the majority of people say. Such a psychological tendency will almost certainly cause people to think that the further a trend goes in one direction (whether upwards or downwards), the more it seems like a "friend", and the safer it seems to join this "friend". As such, most traders and investors have a misplaced confidence in the "friendliness of trends".

This statement is true if we apply it properly in the psychology of our decision-making process in trading. The general idea is to avoid getting onto a trend when it becomes clear to everybody, so that we reduce the chances of joining a trend when it is near its end. Therefore, we need systematic rules to guide our entry onto a trend when it is in its early stages. It is important, however, to note that while doing so, we must not be obsessed with "second-guessing" whether the trend that we get onto will indeed be strong enough or whether it will be a "false signal" that reverses it course.

The truth is that no entry setups will allow us to capture only the strong trends. In fact, our goal is not to predict only the strong trends because that is unrealistic. A simple entry setup designed to capture the early signs of all potential trends, when coupled with good exit strategies (designed to cut losses short when there are false signals and let profits run when there are strong trends) will be very profitable when being used consistently. Those exit strategies that allow our profits to run will truly testify to the truth of the statement "the trend is your friend".

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