It is commonly believed that our emotions and feelings lead the behaviour of the market. Market psychology is an important concept in behavioural economics which manifests that collective reactions of the market members actually shape up financial market. Warren Buffett rightly says that the market is a device for transferring money form the impatient to the patient. He simply suggests that be patient when you invest because this is the impatient behaviour which ultimately leads you towards a blind alley. Our profits or losses directly depend upon our sensations and emotions.
We generally believe that we think logically and this is the logic which guides us to take necessary actions. In this regard, Neuroscience says that our brains are not as logical as we believe. It means we do not take any decision rationally, especially when it is a matter of money. We start solving money related matters by listening to our heart. We start taking actions by involving our feelings and emotions.
There are certain factors which control our mind or make us illogical while taking money-related decisions i.e. cognitive biases, emotions and psychological processes etc. While trading or investing our actions should be based upon reason instead of our instincts.
Amygdala, part of the brain, makes us impulsive and we make rash decisions during market downturns. This part of the brain creates fear and sparks the response of fight or flight. At this point if we think logically, we shall fight to our fears otherwise we will become slave to our emotions. The other part of the brain, ventromedial prefrontal cortex, which assesses rewards makes us overconfident during bull markets.
The Role of Psychology in Driving Market Cycles
Uptrend
It is rightly said that optimism brings prosperity. Rising prices during bull market makes investors excited. This excitement sparks the reward system of the brain which releases neurotransmitter dopamine.
FOMO (Fear of missing out) is an emotional phenomenon which stems from the brain’s social reward pathways. FOMO is basically the fear of missing out an opportunity or chance. Commonly, we always want to include ourselves in anything that is beneficial for us. If wo do not get that chance, we start thinking that we have missed a golden opportunity. On the other hand, all social media platforms start displaying the success stories of the people who took advantage of that opportunity. These success stories are shown to people to attract them to invest. People without thinking and realizing the market trend and with the fear of missing out, start investing at a very risky time of the market.
The value of meme coins is especially overhyped. Just by looking at the viral trends people start investing in meme coins which contain no intrinsic value. TRUMP, DOGE, MELANIA and SHIB are the example of the meme coins. Traders should not invest in these meme coins just by looking at the hype and viral trends. They should keep an eye on the ignoring warning signs line overvaluation.
Numerous neurological processes are involved in creating unchecked optimism which ultimately leads to the creation of financial bubbles. When this financial bubble bursts, it creates negative emotions among the investors. For this reason, before investing, they should know the true value of an asset.
Downtrend
During bear markets, the emotions of the investors get changed. The emotions of fear and denial penetrate in them deeply. They start panic selling which ultimately proves more painful for them. The investors’ fear leads them to capitulation (A point where investors sell their holdings at a significant losses).
When the pessimism of the investors is at peak, market generally stabilizes. Some investors come back and by taking certain precautionary measures they try to re-enter the market. While re-entering the market, they take with them the intrinsic hope and optimism which keeps them motivated.
Neurobiology Behind Market Psychology
In the making of psychology behind market trend Certain complex neurological processes are involved. This reward pathway consists of many neurotransmitters. Dopamine is the main transmitter which is linked with reward and pleasure. During bull market, our brain answers by releasing increased dopamine. When we think of financial rewards our brain’s dopaminergic pathways are triggered. Dopamine travels through different pathways and reaches at the different regions of the brain.
Mesolimbic is the pathway which is associated with market psychology. It connects ventral tegmental area to the limbic system that also includes amygdala. When we expect a reward dopamine is released through this way. This increase of dopamine is responsible for bringing motivation and satisfaction.
Dopaminergic pathways are associated with bull markets while amygdala is linked with bear markets. Both are significant in their own way. Amygdala is responsible for triggering the sense of fear and anxiety. This sense of fear leads the investors towards rash decision making. There is another term, cognitive dissonance, which stops investors from making rash decisions. It compels the investors to hold their assets and make them believe that there are possibilities that the market may recover. Cognitive dissonance is linked with prefrontal cortex and the limbic system. Cognitive dissonance is experienced when reality conflicts with the beliefs of the investors.
Mirror Neurons Lead the Investors towards Imitation
This is another aspect of neurobiology which leads the investors towards imitation. When the investors see someone becoming successful, it leads them towards imitating them. Basically, mirror neurons permit the traders to experience the feelings and emotions of others. Mirror neurons are involved in sympathy and other social influences. These neurons get activated when an investor performs an action or when he sees someone else doing the same thing. Mirror neurons are found in premotor cortex, the supplementary motor area, the parietal lobe and the inferior parietal lobe.
TRUMP Meme Coin: A Case Study
1. Rapid Growth and the Dopaminergic Pathways
As Donald Trump was a prominent figure in personality and wealth, he caught the attention of the investors during the initial surge of Trump meme coin. Another factor which contributed to the initial surge of Trump meme coin was FOMO. People started expecting great rewards which triggered the dopaminergic pathways of the investors.
2. Herd Instinct and Mirror Neurons
Earlier we have discussed in detail that when the investors see someone becoming successful, it leads them towards imitating them. These neurons get activated when an investor performs an action or when he sees someone else doing the same thing. In the case TRUMP:
Meme Culture: Social media and meme culture played a key role in promoting and making TRUMP Meme coin a trend for the investors. This encouraged the investors to invest just by looking at the social media hype or by following the path of other traders.
Political and Fanbase Engagement: Investors’ adoption of TRUMP Meme Coin saw an initial surge just because of the name and fame of Trump. Positive words of mouth and the support from the fans, TRUMP Meme Coin was adopted in great number by the traders.
This clearly shows that positive words of mouth, meme culture and herd instinct can clearly play a significant role in driving market behaviour.
3. Volatility, Panic Selling, and the Amygdala
TRUM like other meme coins also experienced volatility after the initial surge. It did create a sense of anxiety and fear in the traders. This sense of fear leads the investors towards rash decision making. Cognitive dissonance may guide the investors to hold their assets inspite of the downturn of the market. There occurs the conflict between reality and belief and ultimately this conflict becomes the cause of rash decisions on the part of investors. Rash decisions often bring losses for traders.
Amygdala amplifies the emotions of fear and anxiety and ultimately drives panic selling. In this regard we can say that external factors do play a key role in changing the behaviour of an investor and setting the trend for the market.
Conclusion
In conclusion it can be said that the psychology behind market cycle plays a crucial role in determining a market trend for the traders. Emotions in trade do affect market trends. The emotions of optimism or pessimism affect market prices. If you know the neurobiological processes, the role of dopaminergic pathways, amygdala and mirror neurons you can get more knowledge of market psychology. The knowledge of market psychology stops you from making rash or illogical decisions. It can save you from panic selling, FOMO and cognitive dissonance and paves the way for secure and unbiased results.
