Psychology in Prediction Markets

psychology-in-prediction-markets

Humans are social creatures driven by emotions. Everything we do is in some way a result of our emotions or lack of emotions. That said, no two people have the same psychological makeup. Some people control their emotions better, while others tend to be guided by theirs, and this is one of the main reasons we see that some binary options traders tend to be very successful, while others struggle to break even in their trades.

In other words, for a trader to be successful, he must be the master of his psychology while trading.

There are three (3) primary emotions that a trader must overcome to trade effectively. They are:

– Fear
– Greed
– The “Lemming Effect”

Fear

Fear is a natural innate survival instinct. When we feel threatened, fear takes control of our minds to lead us to face danger or flee from it.
In binary options trading, this fear is caused by fear of losses. When confronted with losses due to market forces or wrongly predicting how an asset price will move, we can feel threatened. Unfortunately for most traders, when faced with losses, their primary instinct is to hold onto their investment in anticipation of the market turning around. Some even invest more in the hope that they can cover their losses when the market turns around.

Greed

We have all seen the movie “Wall Street” where the main character “Gordon Gecko” talks about how good greed is. Unfortunately, this only happens in movies. In real life, when it comes to trading in a fast-paced market where the trade runs in a matter of minutes, greed can be a destructive emotion. Due to greed, a winning position can quickly turn into a loss; when we stop liquefying our position before the market falls. The insatiable appetite for more profits can easily make you forget about your trading plan or start going over your limits.

The “Lemming Effect”

Lemming is an animal known to blindly follow the crowd and fall off a cliff to its death and thus the “Lemming Effect” metaphor. In reality, human beings possess this psychological phenomenon. We can easily see the result of this behavior at work in the dot com bust bubble and, more recently, in the collapse of the housing market in the US; we lose our sense of judgment because we want to “follow the crowd.”

Conclusion

Overcoming emotions such as fear and greed is never an easy task in binary options trading. Also, there are no hard and fast rules that we can follow because we are all different people. What works for one person may not work at all for another. The best advice for mitigating these two emotions is perhaps to be aware of them during the heat of the negotiation and then walk away from the talks. As for the “Lemming Effect,” the best way to counter this is to do our investment analysis before taking the plunge. Only if we feel that it is a success, then we invest our money in the options.

 

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