The emotion cycleWhy the crowd buys high and sells low.
Most retail traders buy when they feel great and sell when they feel terrible, which is exactly the wrong way round. The cycle of market emotions shows why, and how to keep feelings out of your decisions.
Why trading gets emotional
Many people come into trading for the excitement and the chance of quick money, a bit like the rush a gambler gets. That makes their decisions emotional from the start. They react to rumours and to every swing in price instead of following a plan.
The result is impulsive trading. A rumour on social media becomes a buy, and a sharp red candle becomes a panic sale. Each decision feels reasonable in the moment, because the feeling is real. The price does not care how you feel.
The lesson on trading the data showed what one feeling can do to a single trade. Across a whole market swing, the feelings of the crowd follow a pattern you can learn to read.
The cycle of market emotions
There is a well-known picture of how these feelings play out over a full market swing. It starts with optimism. As the price rises, optimism turns into enthusiasm, then exuberance, then euphoria, the feeling of being on top of the world. “I’m very pleased with my investment.” That is the point of the highest financial risk, because everybody who wanted to buy is already in.
Then the market turns. First comes anxiety, then denial: “It’s only a temporary downturn. I’m in it for the long term.” Fear follows as the losses grow, then panic, and finally capitulation, the moment you give up and sell everything.
Around the bottom the mood is despair and discouragement. Then the price starts to recover, and the feelings follow it: hope, relief and finally optimism again. Many traders go round this loop again and again until the account is empty.
Greed buys the top, fear sells the bottom
The cycle explains why so many retail traders do the opposite of what works. Greed makes them buy near the top, when everything feels safe. Fear makes them sell near the bottom, when everything feels hopeless.
Euphoria is dangerous because of what it means for supply and demand. When everyone feels great, almost everyone who wanted to buy has already bought. Little fresh money is left to push the price higher, and a lot of people are sitting on gains they will sell at the first sign of trouble.
Capitulation works the other way. When the last holders give up and sell everything, the selling is nearly done. That is why the moment that feels worst is often the best time to buy, and why it is so hard to do.
Let the plan make the decisions
Every trader feels greed and fear, and you will too. The goal is to keep those feelings away from the order button.
That takes 3 things. Discipline, so you follow your rules when you would rather not. Risk management, which means deciding in advance how much you can lose on a trade, so a bad moment cannot turn into a disaster. And proper research before you click, so every entry has a reason you could write down.
Use your feelings as information. When you feel euphoric about a trade, treat it as a warning sign. When you feel like giving up and selling everything, check the data before you sell. If the reason for the trade still holds, the plan decides.
The cycle in your own trading
Euphoria shows up as bigger positions and looser entries. If you catch yourself raising your risk because you feel unbeatable, go back to your normal size.
Denial sounds like “it’s only a temporary dip”. If the reason for the trade is gone, let the stop do its job.
In short
- The cycle of market emotions runs from optimism to euphoria, then through anxiety, denial, fear and panic to capitulation, and back through hope and relief.
- Euphoria is the point of highest risk, because everyone is already in. Capitulation is often the best time to buy, because the selling is nearly done.
- You will feel greed and fear. Discipline, risk decided in advance and research before every trade keep those feelings away from your decisions.
Key terms
- Capitulation
- The moment when the last holders give up and sell in panic. It often marks the end of a fall.
- Risk management
- The rules that limit how much you can lose: risk per trade, total exposure, stops and when to stand aside.
- Retail trader
- A private individual trading their own money, as opposed to banks and funds.