Psychology and the Financial Markets: Why Trading is Far from Just a Numbers Game

On the face of it, financial market trading may seem like a strategic numbers game.

While this is at least partially true, however, it does not do justice to the complexities and hidden depths that define the course of multiple markets and derivatives. After all, if financial market trading was based solely on numerical aptitude, traders would not require the level of education and knowledge that remains a prerequisite of success in 2014.

In fact, successful trading is as much about psychology and determinism as numerical ability, as there remains a pressing need for investors to tap into their instinct without allowing emotion to dictate their strategy. This is the ultimate balancing act for traders, and one that will ultimately make or break their chances of success in a real-time market environment.

The History of Psychology in Financial Market Trading

If there in concept which underpins the importance of psychology in financial market trading, it is Bill Williams’ unique Chaos Theory. On a fundamental level, it argues that the level of individual success secured through the financial markets is determined by human psychology, and the ability to uncover determinism in seemingly random market events. The latter aspect of determinism is particularly important, as it enables traders to discover a natural order in the financial market and pre-empt trends according to the underlying laws that govern change.

This theory also has its roots in the Chinese philosophy of Taoism, which is the subject of numerous teachings and literary studies. It essentially recognises that while the world and its individual aspects are constantly evolving, the fundamental laws that dictate change remain unaltered. When applied to exercises such as investment and financial market trading, it enables individuals to operate according to a more in-depth understanding of their environment, rather than sudden price movements or emotive reactions alone.

Many successful investors have built their wealth on such strategies, and there is an argument to suggest that human psychology is a far more valuable weapon that any technical indicator or analytical tool. This suggests that the latter features do not have the capacity to secure long-term gains and profitability by themselves, simply because they become less effective in nonlinear dynamic models such as the real-time financial market. These analytical tools therefore require the application of human psychology to achieve their full potential, as traders consider data in line with their own self-awareness and an innate understanding of their chosen market.

The Rise of Automated and High Frequency Trading (HFT)

Despite the persuasive content of these theories, human psychology continues to be an understated aspect of financial trading. This is especially true in an age of automated and high frequency trading, which utilise predetermined and strategically programmed algorithms to execute multiple orders in milliseconds. These contemporary methods of trading essentially reduce the role of human instinct in executing investment decisions, and their practice creates a clear divide between those who herald their efficiency and others who consider them to be unethical and detrimental to the financial market.

The controversy surrounding these methods has forced international regulators to consider the implementation of more stringent guidelines, with a view to minimising any potential increase in financial market volatility. More traditional traders would also question the effectiveness of automated trading and HFT strategies when applied to the pursuit of long-term gains, as the lack of direct human interaction is likely to prove detrimental in a real-time market over a prolonged period of time.

In many ways, contemporary online brokerage firms help traders to strike the ideal balance when it comes to utilising both human psychology and technological tools in the pursuit of their fortune.  More specifically, they enable investors to access online resources such as demo trading accounts, relevant technical indicators and real-time financial market newsrooms, while also providing them with a platform from which they can customise their experience and apply their core investment philosophy to influence individual trades.