Do you follow the crowd?
When it comes to trading, do you follow the crowd? We as humans have a natural tendency to do so, but when trading the markets, following the masses can often lead to losses. Unless we are in the middle of a trend, it doesn’t normally pay to be on the side of the masses. Expert market timers will identify trends so that they can jump on board to profit, but very often, that decision will be in direct conflict with the prevailing market sentiment.
Your ability to take trades that go against what the crowd are doing may have a lot to do with your personality type. Like we have already said, we are pre-programmed to follow the crowd – it’s all part of our survival instinct and is what has enabled our species to flourish. It also occurs throughout much of the animal kingdom too, be it schools of fish, flocks of birds or packs of wolfs to name but a few.
But when it comes to trading the markets, following the crowd is not such a good idea. Although trends are created by the masses, those same masses will be buying stocks at the top of a rally and selling right at the bottom of a correction. So we have to trade independently from the masses for much of the time. This is more difficult to do than one might think as the euphoria of market tops makes us instinctively want to buy more or at least not to sell when in fact that is exactly what we should be doing.
How do we trade against the crowd? There are sentiment indicators available such as the put/call ratio and volatility indexes, but you can also use your own emotions as a guide. If you find yourself extremely bullish towards the markets after a strong rally, you might want to use this perfectly normal human emotion to be a bit more cautious. Likewise, if the markets have been falling and you find yourself feeling extremely bearish, watch out for a rally…