The Enemy Within
Buy Low and Sell High
Seems easy enough to understand and follow. Yet most of us are unable to keep this simple rule straight in our heads when it comes to the stock market.
Proof
If we see others buying stocks, then it must be a good time to buy. The same goes for when everyone else is selling.
Scarcity
We will rush in and buy stocks at Rs.100 because we are afraid that in a short time they will only be available for Rs.120, Rs.150, or much more. We must buy it now, because this price may not be available for much longer. That is why when the stock market is rising, we feel a great need to jump in and buy, buy, buy. As the market rises, stocks at lower prices become more and more scarce, which creates more buying, which makes them more scarce, and on and on it goes until the music stops.
We like making money, but we hate losing money a lot more. That is why when there is a large drop in the stock market and we have lost a lot of money, we are shy about buying more. Once we have lost, we want to hold on to what we have for fear of losing more. This makes us most likely to buy when prices are high, because we have lost nothing and have gained much (at least on paper). Similarly we are likely to sell or at the very least, not buy, when prices are low.
When prices are high, we are most compelled to buy because that is the time when there is most competition for a stock. We must get it now before someone else gets it and makes money that should be ours. When prices are low, we are compelled to sell because we do not want to lose the opportunity of getting rid of our crap to someone else.
Why do so many people lose money on the stock market?
Because the rules of 'Scarcity' and 'Proof' are steering us to buy high, and sell low. In this case, we are our own worst enemies.
Now that we understand the psychological forces arrayed against us, is it possible to counter those forces?
Stocks are not like regular items. We cannot eat stocks, or use them in any tangible way. We either buy them as a long-term investment, or hope to make some short term money through a quick trade. For short term traders, the amount of money that can be made is actually dependent on the short term demand surrounding it. This short term demand, as we have laid out, is based on 'Proof' and 'Scarcity'. In this case, we want to encourage greater 'Scarcity', 'Proof', and whatever else we can throw at it to drive prices further up, so that we can make some short term profits. There are also many so-called experts who will appear on TV, send SMS / Messenger and tout particular stocks in order to artificially inflate their values so that they themselves can make a quick sale. In this way, the more competition there is, the higher price you can sell at in the short-term, and the more money you will make. And that is why trading is very much different from investing.
When you make short-term trades, it is important to understand the psychology behind the stock market, and to use that psychology to your short-term advantage.
If you are a long-term investor, you want to be aware of these short-term tricks that people may pull on you, in order to psychologically manipulate you to buy at too high a price, or sell at too low a price.
Zerodha (Trading & Demat Account)
RHP
