Crypto Academy / Season 3 / Week 2 - Homework Post for professor @asaj

1. The case study given is an example of what type of psychology? Explain the reason for your answer.

The case of study given is an example of trading psychology, as it has to do with the emotions of a single individual, Jane, through a given period of time. It shows the different emotions Jane goes through along different time frames and how those reactions affects decisions she makes regarding her investment. Buying more to invest when the price kept falling hoping to make greater profit, to the point where her emotions were already clearly frayed and she kept opening her trading app everyday till it got to panic and eventually, the trade was closed.

Clearly, this is the case of the psychology of only Jane, being affected by the market psychology aas a whole. The market psychology is basically, the general emotions of traders at a particular point in time. This is usually what affects how the market goes at different points in time. Jane was basically, reacting to market psychology at different times throughout the process.

2. Using the case study above, list and explain at least 5 biases that influenced Jane's trading behavior with examples of how it affected her behavior.

From the case study above, it can be seen that Jane was influenced by:

• Emotional bias
• Confirmation bias
• Self attribution bias
• Herd mentality bias
• Anchoring bias

Emotional bias: This has to do with making decisions based on the individual's emotions at that moment. Some of these emotions may include greed, fear and others. In the case of Jane as showed above, she displayed greed at the beginning, where she had entered the market based on advice from the telegram group, made little profit and then wanted much more, hence holding onto that coin for a longer time than she would have and going ahead to buy more coins when it fell even more hoping to make even greater profit by buying really low and selling high.

Another emotion Jane displayed here was regret. Remember, she wished she had entered the market when the price was still way lower and she regretted not taking the advice of the group back then and hence, her unreasonable buying of more coins, ignoring any voice of reason.

Confirmation bias: Confirmation bias is more like refusal to accept the good and bad sides of a particular decision and making decisions after analyzing both. Instead, the trader shuts his eyes literally to opinions not in support of his own and rather, focuses only on certain opinions and signs that supports his own opinion, telling himself he's right in his opinion and going ahead to make that decision.

In Jane's case, when the price of coins started falling, she decided to buy more, fixated on the fact that it would go up and give her more profit and ignoring every other possible negative indicator.

Self attribution bias: This is basically, self conceit. It happens when one blames others and things around them when their trading decisions don't favor them but only take credit when things are going well. Looking at the case study, Jane, she showed this when she thought she would do better buying at a much lower price than people in the group and if she had turned out right, would have been really proud of herself but turned around and blamed the stop loss she set when it seemed the market had corrected itself and she had sold early.

Herd mentality bias: Basically, this means going along with whatever decisions the crowd is taking regardless of whether it sits well with your own personal analysis or not. Jane had done this by relying solely on the information the telegram group provided at the beginning to buy that coin without conducting any further research on her part but just buying because the group chat said so.

Anchoring bias: This has to do with making decisions based on the initial feeling a trader got when he checked out the trend or just focusing on a particular opinion and going along with it. Sometimes, it sets the pace for how that trader trades for a while. That initial trend or opinion becomes the anchor on which the trader continues to some extent. In the case of Jane, she started out good with an uptrend and she expected that the trend would generally keep going up despite some pullbacks.

3. List and explain how each bias you mentioned can be avoided

Emotional bias: Jane can avoid emotional bias by knowing that not all trades go as planned. To avoid making bad decisions, she needs to conduct proper research and analysis before jumping into any conclusions. She should also know to set aside her emotions when making trading decisions.

Confirmation bias: Jane can avoid this by examining both positive and negative opinions of whatever decisions she plans on taking and if possible, jot them down. This way, she can have a clearer, unbiased view and take a decision, after weighing both sides and knowing possible outcomes.

Self attribution bias: Jane can avoid this by accepting she's responsible for whatever is the outcome of decisions made, good or bad and noting them instead of just overconfidence in her skills. This will help her to know her faults and strong points better and hence, do better in future trades.

Herd mentality bias: Jane could best avoid this by conducting proper research and analysis despite what the telegram group is saying and making a decision only after going through all available information she got from her own research and not just relying solely on the group and what the crowd is saying, knowing that if the majority of the crowd starts buying a coin, it could lead to that coin being overbought.

Anchoring bias: Jane could also avoid this by analyzing decisions from different angles before standing on one. She should realize that trends are very volatile and one shouldn't focus on how things may seem at a point in making subsequent decisions or making decision relying on analysis from just one particular angle and not checking others. In the case where she expected things to generally keep going up as it had been for a while, she could have avoided this by knowing that the trend wouldn't generally remain an uptrend forever expected things could also turn around.

Part B (Research and Analysis)

4. What type of analysis can be used to monitor market psychology and trading psychology and why? Identify the differences between trading psychology and market psychology.

Technical analysis can be used to monitor market psychology and trading psychology. Technical analysis involves analyzing different trends indicated on charts in different time frames to know how people are feeling generally in the market and coming up with speculations on how the next trends will go.
Difference between trading and market psychology and reason for technical analysis

1. Market psychology refers to the overall emotions of different individual traders who constitute the market at a particular point in time. Trading psychology on the other hand, is the general emotions which a single individual in the market is feeling at a point in time which influences the actions they take in trading.

2. The market psychology affects shift in prices. However, it is the collective trading psychology of the different individuals in the market that affects shifts in prices.
   Knowing well that these trends are as a result of market psychology at different points, formed by the trading psychology of different individuals in the market, it can be fairly assumed that the charts are a summation of how the public is feeling about that token so technical analysis provides efficient tools to monitor the market psychology, as it deals on analysis based on charts showing trends.

Technical analysis is also used to monitor trading psychology as an individual in the market reacts to emotions based on the market psychology at that point in time and makes decisions based on these emotions. A typical example is shown by panic selling when downtrend persists for a while because the general market is feeling negative about holding onto that token.

Some technical analysis tools includes the MACD, which stands for the Moving Average Convergence Divergence, the Directional system used to identify trends which could serve as indicators, Momentum and Rate of change, which compares recent value of prices to earlier ones, usually used to get when to get a sell signal and several other tools.

5. How can you measure market psychology using a crypto chart? Select 5 trading biases and explain with screenshots of any crypto currency chart how the biases can cause a coin to be oversold and overbought.

A crypto chart is used by crypto traders when conducting technical analysis as it gives us a view of crypto data that we can perform technical analysis using. Since market psychology can be studied using technical analysis, we can easily use technical analysis tools mentioned earlier to monitor the general emotions of traders at different points.
Using the screenshot above, I will talking about certain trading biases.

From the the graph above the lines represent trends in the market.
When you say the market is overbought, it means that a lot of people are buying that asset without any in depth reason and it's price keeps rising, till it gets to an extent where it's value is far higher than it's intrinsic value at that point. Usually, the market corrects itself and reverses.

When you say the market is oversold, it's simply the opposite of an oversold market. In this case people keep selling that asset and the price of that asset plummets till it gets to a value far below the actual value at that time. A correction usually occurs at this point also.

i. Emotional bias: People in the market see that the price of Bitcoin has been climbing steadily. Generally, they want to key in, trade and invest. People buy this asset not minding that the asset is already overbought because they want to squeeze out as much as they can from the market, even when it gets to the point at 36630.44 where it tips over and starts coming down, they still hold on because of greed. He's happy and wants to get as much as he can squeeze from the market so he decides to hold onto his coin, not minding if the coin is clearly overbought. Eventually, at that point, the general emotions of the market is greed and this is an emotional bias.

ii. Herd mentality bias: That point when the market was steady going up and kept going up, at that point, people still buying were having herd mentality bias, generally going along with the trend, eventually causing the market to be overbought.

iiii. Confirmation bias: At the point the trend tips over and is initially plummeting downwards because it has been overbought, certain individuals want to sell out before they start running into a loss but others even seeing that the market was clearly overbought and was definitely meant to go down, start finding certain predictions that confirm to their thinking that it would still go up a bit and refuse to listen to any other negative opinion.

iv. Bounded rationality bias: This bias comes about when traders think more short term when making long term investment decisions because they want to see profits almost immediately. When the market trend tips and start turning over, they rush to sell, because they're afraid of further losses, not waiting for a possible rebound before it goes back down because it doesn't come to mind or they don't have the mindset of waiting. These people contribute in causing the market to be oversold.

v.Disposition bias: As the price keeps going lower and lower and the downtrend persists, a trader keeps holding onto his coin even when he keeps losing more, when he could just sell off to cut down on his losses. He hopes that the market would become oversold very soon so it then corrects itself and goes back up.

6. In your own words, define the term "Efficient Market Hypothesis" (EMH) List and explain the advantages and disadvantages of Efficient Market Hypothesis.

Efficient Market Hypothesis, EMH, is a hypothesis, which states that it is basically impossible to beat the market using either technical or fundamental analysis, as every information about the market is quickly reflected in the prices and the market is efficient. Therefore, traders and investors who wish to get huge profits have to go for riskier investments, as no amount of research can make one earn above normal market profits.

This theory is increasingly getting more attention in recent times although there are a lot of arguments for and against it and certain people, like Warren Buffet, have time and again, proven this theory wrong. There are also some markets which are less efficient than others. We have three forms of Efficient market hypothesis, based on the level of efficiency of the market.

Weak EMH: In this case, it is believed that one can't use history of prices to predict how prices will go, hence investors cannot use technical analysis to predict how prices will move. Fundamental analysis however, could be effective when investors make proper research

Semi-strong EMH: In this case, it is believed that technical and fundamental analysis can't be used by investors to make really high profits and the only way is to conduct proper research on information on that investment that the public don't easily have access to.

Strong EMH: In this purest form of EMH, it is believed that no form of analysis can be used to predict market prices, whether using information readily acceptable to the public or not as every single information rapidly reflects in prices. Investors can therefore, only make above normal profits from highly risky investments.

Advantages of Efficient Market Hypothesis

Advantages

1. Saves cost: In Efficient Market Hypothesis (EMF), the markets are more of a reflection of information and no investor, no matter how skilled or well researched could beat the market. Investors therefore, don't need to spend funds in going to get information which gives them an edge over the market as all information related to the market available have already reflected in the prices.

2. Saves time: Instead of actively poring over new techniques and how to get information, an investor saves a lot of time by just investing passively and using time for other things.

3. Reduction in shattered expectations: Everyone already knows the market is speculative and not a means of earning very high profits consistently by following advice of certain experts. This way, investors don't feel cheated by other experts in the process or allow themselves get deceived by fake experts.

Disadvantages

1. Traders who go the extra mile for information are not rewarded for cost of getting these information and time spent.
2. Reduction in incentive as the promise of profits are speculative and fairly reduced. Investors who would have been willing to invest huge sums might lose interest resulting in general reduction in trading volume.
3. Time and again, fundamental and technical analysis has been shown to work in predicting how market prices will go.

Conclusion

Trading psychology deals with the general emotions of an individual trader in reactions to the market prices at that time.
Market psychology refers to the general emotions of traders which causes different trends at different times.

Trading biases have to do with flaws in trader's trading decisions due to certain human reactions to the market. There's a good number of them including emotional bias, confirmation bias and others.
Efficient Market Hypothesis EMF is a hypothesis that claims that any information related to the market is rapidly reflected in market prices and hence no master analyst or researcher can beat the market and make very high profits. The only way to make huge profits is by investing in highly risky investments.