Have you ever wondered why it is that so many people buy into the stock markets or take trades when the risk of loss is at it's highest?
We hear about it every time we see a major market correction and quite commonly we see it in individual stocks as well, especially when there is some news expected.
In this post, I'll be looking at how and why this happens. Why it is that most people buy high and sell low. How not to let your emotions influence your trading decisions and what you can do if you have been caught up and trapped on the wrong side of a trade.
The Fear of Missing Out
As I have touched on before in this previous post, the 4 main emotions that you need to come to terms with if you are want to be successful are:
Of all of these though, FEAR is without doubt the one emotion that you will have to deal with the most and we see 2 forms of it in the markets:
- The fear of missing out or FoMO
- The fear of loss.
For the purposes of this article we will only be looking at the fear of missing out. Fear of loss is another blog post all on its own.
If you have traded for a while then you will certainly have experienced FoMO.
Everyone at some stage gets overwhelmed by the frustration of missing the move they have patiently waited for and breaks their rules. Chasing price though, when it gets away from you, is not good for your bank balance.
You might get away with it a few times but over the long run it will do serious damage to your trading account.
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FoMO and an Apple
The AAPL chart below is a good example of how FoMO works to trap you into a losing trade and shows the recent action associated with the release of their much publicized Apple watch.
The first thing we see is that the price moves up on high volume on the day of release, people rush into buy stock for fear of missing out.
A buying fervor and lots of FoMO has been established beforehand, by an intensive marketing campaign and so interest to "get in on the action" is really high.
The price actually gaps up on the open with buyers jumping over each others buy orders to grab stock. Note: This can also be a deliberate move by the pros "marking up the stock", to get a buying frenzy going. They understand fully how to exploit FoMO.
This is now a very high risk area to buy in at. Why?.. Well, it's because we have supply sitting immediately to the left at the same level on the chart (circled in yellow). This supply is buyers trapped at that level from when the stock made it's previous high. Because of this we would expect some selling to come in, and we do in fact see that on the chart, with the high volume and a relatively narrow bar.
This relatively poor reward (the price hasn't moved far) for effort (the high volume) put in by the buyers, is a clear cut warning that things may not be as they appear. In this case it looks like hidden selling.
We also can't discount the possibility that buyers may be absorbing the supply (selling) from those same trapped in traders. It would certainly pay to be wary and buying in this area is high risk.
The next bar on the AAPL chart (above) is fairly typical of the kind of trap that is set for inexperienced traders who have jumped in and bought at the wrong place because they gave in to their FoMO.
The price gaps up over resistance on the open. This is caused by end of day traders who see the previous days action, are worried they won't get in and set their pre-market buy orders higher and higher.
This of course all adds to an increasing sense of FoMO.
Eventually with the price not making any progress and the realization and expectation of loss setting in, the more experienced traders realise what is happening, selling takes over and we see a low close and wide spread bar.
A lot of buyers from the day before and those who bought at the open are now trapped into a losing position and are deemed to be on the "wrong side of the trade"
We now have a very clear sign of weakness and price will struggle to get up above it until it gets well away from it. Those trapped in buyers will hang on in an effort to get their money back and so we see them selling when price moves back unto the levels they have previously purchased at.
This is why we always pan out to a larger timeframe so we know where previous highs or significant price levels are located.
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The Optimism at the Top
We really see FoMO at its clearest when we look at market tops before large crash events. We notice in these situations before these major crashes that everyone is very bullish.
Typically we will see the media constantly reporting on and talking about higher stock prices . Experts and Stock "gurus" make regular appearances on TV and in the media spruiking about future highs and urging people not to miss out. Obvious signs of weakness on the charts get ignored and even taxi drivers seem to become experts in the stock market.
If you are not in the market at this time and you are surrounded by all of this really positive news and information, you may start feeling really anxious about being left behind. If you see friends and family involved then that feeling gets even stronger and you'll want to get in on a "slice of the action" too.
This is classic herd mentality in action. Caution is thrown to the wind and of course this is when we see people piling into the markets late, buying heavily at market tops and setting themselves up for massive losses.
It's interesting to see that after these crash events we always see numerous stories in the media of bankruptcy and loss of life savings and everyone blaming the markets or someone else.
Frustration and revenge
So what is the typical sequence of emotions we would expect to see someone experience during this whole process?
The diagram below takes us through a typical trading situation and highlights the shifts and types of emotions experienced in relation to the trading action at the time.
The market or stock moves quickly and you miss the move
Prices move higher with no visible pullbacks or pauses
The trader then starts buying in as odds of a pullback increase
The market or stock falls
Fear, Hope, Revenge
Of course once anger and revenge set in then more losses are usually inevitable. Amateur traders soon find themselves in a downward losing spiral as they seek revenge by averaging down or taking trades against the direction of the trend. This usually then leads to larger and larger losses.
If there actually was any kind of a trading plan to start with, we can pretty safely assume that at this stage it has long ago been abandoned and replaced by rash decision making and emotional pain.
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Caught on the Wrong Side of the Trade
So what do we do if we find we have given into FoMO and are trapped and losing money on the wrong side of the trade?
Believe me everyone who trades the market will have experienced this at some time or another and it really can cost you dearly, depending on how you react.
Here are some points you might want to consider if you find yourself in this situation.
- Acknowledge your mistakes - Its never a bad thing to be wrong, the sooner you realize it the sooner you can get out.
- Learn to cut losses - Do it quickly and unemotionally.
- Look at the chart - How far away is support, is the stock oversold? Is there a high probability of a bounce or a turnaround to exit at a better price, or is it better to sell, take the loss and live to trade another day.
- Plan - Define the steps you intend to take to get yourself out of trouble and act on your plan without question. If part of that plan is to sell and move on. Do it! Don't be trapped in by hope.
FoMo is a powerful and potentially destructive emotion and sooner or later you will experience it. Don't give into it when you do, embrace it and understand it. Realize that your emotions are there as your warning system. Use them as your feedback mechanism to alert you as to what is really happening. Be aware and don't let it tempt you into poor decisions making.
Remember that just because you may have missed the bus, it doesn't mean you can't still reach your destination. There will always be another bus along later...be patient and wait for it to arrive!
Thanks so much for reading this article. I hope you get something out of it that will help you on your trading journey, best of luck, and if you find this post useful, please use the sharing buttons below to spread the word!