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Do emotions matter in trading?

Emotions and Trading

I have heard some very professional experts saying “Emotions should be kept out of business or trading”. So do emotions really do more harm than benefit ? Lets discuss some details about it and dig some facts.

Why do stock prices rise?

There are many reasons that stock prices rise but lets broadly classify into two:

  1. The company is performing well with growth potential or better dividend yield.
  2.  Because everyone is buying.

Doesn’t (ii) sound very familiar ? If everyone starts buying lots of gasoline for cars over the long weekend, everyone starts buying property in a specific locality, everyone starts buying tickets for the baseball games, prices will go up. People will be ready to pay premium price. Doesn’t this (ii) option sound less logical and more emotional ? So basically sentiments do govern the prices ! From the moth of an economist it is the same demand and supply principal.emotions

Emotions and stock prices

So we do realize that sentiments are important in stock prices. When you buy stocks you either trade or invest. Difference is that you trade for a short period like ‘daily trading’ or invest for a long term hoping to get dividends and expecting the stock price to increase in the long run. So if you are a long term investor, hold on your sentiments and carefully analyze the company, check Earning per Share(EPS), Dividend given since last couple of years, the Price to Earning(P/E) ratio, the market capitalization and growth prospects of the company. Some good examples are Apple(AAPL), Amazon(AMZN), Microsoft(MSFT), General Electric(GR). Another aspect is that ‘institutional investors’ trade in high volumes as these are financial institutions, mutual funds or banks. The trading by these institutions is mostly done using computer algorithms and individual investors like us just see the trends and start following it.

On the other hand if you are a ‘daily trader’ and like to buy or sell daily contracts of stocks(long or short), what matters is the market sentiments and volume within hours or within a day. As a daily trader you just care about completing the buy and sell trade within the same day and not worried about company’s long term profits and future.

So market sentiments and emotions do matter depending upon your trading strategy. Remember there is no set formula for every scenario. At times you may prefer stable stocks while other days you may want to take risk by buying rapidly moving stocks. High volumes give you indication of market sentiments. You need to be aware of the latest news and how it will impact the industry. Fluctuation in Oil prices, change in interest rates, currency(dollar) value changes, political turmoils and even natural calamities bring changes in moods and sentiments of the investors. Some of these events are also the data points in the softwares which are used by institutional investors for high volume buying or selling. So money may not have emotions but people who trade in money do have and it impacts.  

Author: Gagandeep Singh

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