Traders Must Break Away from the Herd
06/21/2011 7:00 am EST
There’s often safety in numbers, but when trading or timing the markets, it doesn’t pay to follow the masses and copy their mistakes. Here’s how to break free and go against the crowd in search of profits.
Humans have a natural tendency to follow the crowd, but when timing the markets, following the crowd can often result in losses. Unless you are in the middle of a long-term trend, it usually doesn't work to conform to the masses.
Expert market timers know how to spot trends, and they make sure to climb on board and profit, but often, the very same buy and sell decisions that must be executed to jump on board that trend are in direct conflict with current market sentiment. It is not easy to make that trade when it seemingly conflicts with what everyone else is doing.
Interestingly, your ability to break away from what the masses are doing—and away from current sentiment—may have a lot to do with your personality.
Following the Crowd
There is safety and comfort in numbers and in following the crowd. Across the generations, people learned that survival depended on banding together and working as a group. All humans inherited this legacy, and it is shown in the security we feel when we follow the crowd.
The most successful members of society have seen the virtues in following the crowd. They have learned to look for rules to follow and to decide which standards to strive for. Blind obedience to authority may not be beneficial, but compromise is.
To be successful, it was vital to protect one's self interests but also stay within the bounds of acceptable behavior. Although you've been frequently warned about the pitfalls of following the crowd, it's important to recognize that it is a survival instinct that is ingrained not only in humans, but in most animals, too. Think of herds of deer, flocks of birds, swarms of insects, schools of fish…there is safety in numbers.
Going Our Own Way
Although following the crowd isn't bad all the time, such as during a long-term rally, there are times when a market timer should not follow the crowd.
If all we had to do to be profitable was follow our instincts, we would likely be making the same buy and sell decisions as the vast majority of traders. But just as the vast majority of traders are not profitable, as market timers, we want to "break away" from their emotional trading in order to be profitable.
Market timers trade market trends, and trends are created by the masses. Those same masses who are buying stocks at the top of a rally and selling stocks at the bottom of a correction. This means that most of the time, as market timers, we must go our own way. And right there is the crux of the problem.
As soon as our timing strategy, which is not based on the emotions of the masses, issues a buy or sell signal contrary to the current sentiment, our very human survival instincts kick in. We want to stay with the crowd. It is hard to do what your instincts tell you not to do. But those market timers who are successful have learned to do just that.
By Frank Kollar of FibTimer.com