If money holds the power to bring up a lot of emotions within your mind, you’re not alone. The relationship between people and everything that is money-related elicits a plethora of emotions, and you should know that this response to money is not wrong in itself. The problem arises when these emotions shift into irrational behaviors that cause you to make biased decisions, generally detrimental to your investment goals. Optimism, excitement, thrill, anxiety, euphoria, denial, and fear are just a few of the numerous unconscious biases that might influence investing behaviors, with emotional management as a crucial skill that, as a trader, you must master in the volatile cryptocurrency trading world.
The two basic emotions that directly or indirectly tend to influence cryptocurrency investing decisions are fear and greed, manifesting whether as Crypto trading FOMO and panic selling in falling markets or as confidence and euphoria in rising markets. Thus, the Fear and Greed Index is a compilation of seven indicators that measure stock market sentiment, including volume, volatility, dominance, search engine data, and whale movements. This easy-to-read barometer alerts investors to their own emotions and biases, helping them make informed and favorable choices in the cryptocurrency ecosystem. However, there is much to be discussed regarding the visceral emotions that generally disrupt trading strategies, so let’s find out more.
Fear and Greed
Fear is a predominant emotion that affects cryptocurrency traders and is mainly driven by the instinct to avoid loss. It grips the hearts of investors to the point where they panic sell, remain reluctant to enter the market or hesitate to execute trades. Dealing with this emotion can lead to undervaluation based on a broader sentiment of pessimism, turning bear markets and economic and geopolitical uncertain times into emotional enemies that plague their progress and performance, regardless of their experience.
Greed entices traders to chase after high returns without proper navigation of the market and a clear understanding of the associated risks. Crypto is a game of opportunity, and contrary to the public opinion that highlights the market as your biggest enemy, the biggest enemy is your greed. Aspiring for growth can be beneficial unless it turns into an insatiable desire that prompts you to pour money into overvalued stocks or speculative assets. In short, greed can lead to overleveraging, disregard for prudent risk management practices, and fear of missing out (FOMO).
Overconfidence
Believing in yourself would be good if it had not been for people’s tendency to have too much faith in their abilities, thinking they are more informed than they actually are. Nevertheless, that is what is happening in the cryptocurrency ecosystem where numerous investors rate themselves above average in investing skills and overestimate their expertise, developing an inflated sense of control over assets that, at the end of the day, remain highly volatile. This bias results in poorly considered trades and creates a sense of vulnerability that can ultimately lead to severe financial setbacks.
Humans’ tendency to overestimate their competencies is also known as the Dunning-Kruger effect, a concept named after the psychologists David Dunning and Justin Kruger. This effect has been proven multiple times in the cryptocurrency ecosystem, with countless traders predicting imminent Bitcoin prices by certain dates that have been proven inaccurate. This highlights the importance of avoiding the temptation of overconfidence biases when investing in crypto.
Loss Aversion
Loss aversion is a major cause of trader bankruptcy, manifesting as a psychological tendency to fear losses considerably more intensely than valuing equivalent gains. This cognitive bias causes traders to perceive losses roughly twice as painful as equal gains would feel pleasurable, trapping investors in poor positions through an endless average down of holding onto losing positions with the hope they will eventually rebound, rather than accepting small losses that can make room for better investments in time. Thus, the most damaging consequence of loss aversion is that it prevents traders from accepting minor losses and moving on. By choosing to stay in a losing position, you could lose real money on the trade, relinquishing being in another position that may have the potential to be profitable.
The Herd Mentality Effect
Amid the allure of cryptocurrency stories, the herding effect is a behavioral phenomenon visible among investors in almost all asset classes, with multiple traders making their decisions solely on the actions of others without performing a thorough market analysis or at least the slightest introspection. As we’ve mentioned in the introduction, the cryptocurrency environment is full of emotions that outweigh logical reasoning, with the impulse to imitate the crowd as a particularly strong example. Taking collective action is deeply rooted in crowd psychology and driven by the fear of missing out (FOMO), implying dreadful consequences such as influencing the rationality of purchasing decisions, a trait that cryptocurrency investors must approach with consciousness and responsibility.
Could Proper Management Of Your Emotions Lead To Better Trading Practices?
Emotional investing is an inherent human quality that can be surpassed through discipline and courage to resist group pressure. Here are some strategies to avoid emotional investment while investing in crypto:
- Prudence and accountability are crucial for developing a healthy approach to investing. They highlight the need to set realistic investment goals and master risk management techniques. Emotional intelligence is a critical component in the blockchain sector, allowing for the avoidance of emotional decisions and the courage to accept losses when they are unavoidable.
- Prioritizing a long-term perspective is a massive challenge in a sector where short-term gains are so highly paraded, robbing the patience to perform a deep analysis from traders. However, focusing on the long-term potential of cryptocurrencies helps to determine cryptocurrencies’ intrinsic value and growth prospects, fostering a stress-free approach without concerns regarding daily market fluctuations and short-term trading news. Nevertheless, you should know that a short-term perspective is not undoubtedly damaging per se, but it is a problem when it contradicts your long-term plans.
