There is heavy selling in the crypto market. Our portfolios have shrunk considerably compared to 6 months ago. This situation affects many of us negatively. In times like these, being nice to ourselves is much more important than monetary gain.
What happens in the market is greatly influenced by psychological processes. Behavioral finance is a discipline that studies the psychological underpinnings of investment decisions. It questions the assumption that the actors trading in the markets makes their rational decisions. Studies in this area have identified psychological tendencies that move financial decisions away from the optimum. I will try to explain these tendencies below.
Following The Crowd
No matter how knowledgeable we are, the general pricing behavior in the market influences our decisions. Last fall, people were competing with each other to buy crypto assets that were worth 5-10x compared to the previous year. Nowadays, although there is a big discount on cryptocurrencies, many people are not willing to buy them. Some of the pricing in the market is due to inflation and the expectation of an economic recession. However, changing circumstances are not sufficient to explain such dramatic changes in prices. Those who can calmly approach price movements will undoubtedly be profitable in the long run.
Familiarity Bias
One of the most common pieces of financial advice is to invest in what we know. People are more willing to invest in what they can intellectually penetrate. For example, people feel comfortable buying real estate for investment purposes. Yet they are skeptical about investing a small portion of the same investment amount in crypto. However, getting to know crypto or other investment alternatives can increase the potential returns of investors.
As people learn more about crypto, they start to feel comfortable with it. In this context, the mission of democratization of financial information undertaken by Hive and Leo Finance is extremely important.
Extreme Emotions
Emotions are often opposed to reason, and decisions involving emotions are assumed to be wrong. However, evolutionary psychology reveals that emotions help make the right decisions. It is also possible to consider emotions, the rational foundations of which we have begun to understand in recent years, as extremely efficient calculation tools. On the other hand, when emotions reach extreme levels, they can cause us to make wrong decisions. Excessive pride leads to costly purchases and excessive fear to sell our financial assets below their value. At the time of writing this article, for example, extreme fear reigns in the market.
Reference Price
The price level at which an asset is acquired influences further financial decisions. When we approach the issue from an impartial point of view, it should not matter at what price we buy an asset. Regardless of the acquisition price, if the asset we have offers better returns than alternatives, we should hold it. Or if it has bad price performance from others, we should sell immediately. However, we are generally not willing to give up investments that are at a loss.
On the other hand, the cost of acquiring works in our favor when we are negotiating with someone else. The fact that we do not want to sell our financial assets at a lower level than the acquisition cost allows us to increase the sales price in certain situations.
Confirmation Bias
When we like and adopt a particular financial asset, we tend to see the good in it. Especially if this appreciation has turned into advocacy, we do not have the opportunity to make real evaluations about that financial asset. Thus, we begin to look for evidence to support our conviction about that financial asset. And of course, we easily find the evidence that supports our opinion and ignore the contrary views.
On the other hand, advocacy is not entirely useless. Communities that have a strong belief in a particular cryptocurrency are making sure it increases in value. High prices help the cryptocurrency in question attract new investors. When there is a large gap between the real value and the perceived value, advocacy is not enough to maintain the price at that level.
Overconfidence In Financial Skills
The majority of people see their abilities and skills as better than they are. Finance is no exception in this regard. There are obvious advantages to thinking we are better than other people. On the other hand, the belief that one can predict the direction of the market better than others increases the tendency to take risks. On the other hand, no matter how competent we are in the field of finance, we can't know what will happen in the future. Financial competencies allow us to realistically evaluate possible scenarios. And it helps us get better-than-average returns in some special setups. In this context, knowing the limits of both our skills and financial analysis can help us make the right decisions.
Avoiding Loss At All Costs
In today's financial environment, it is necessary to take risks to obtain significant returns. Otherwise, it will not be possible to protect savings, let alone generate returns. Not being able to tolerate the depreciation of investments means being willing to earn below-average returns in any case.
It is not easy to persuade risk-averse people to invest in crypto. On the other hand, such a non-optimal attitude should be treated with respect.
Conclusion
At the time of writing this article, the prices of crypto-assets continue to fall. Stock markets around the world are also falling. We may be asking ourselves "where did I go wrong".
Our cost of owning cryptocurrencies may be below today's prices. Or maybe we're at a loss. Even if the prices have dropped to historical lows as of today, they will rise over time, as has happened many times in the past. I believe that just like gains, losses are also part of the learning process. On the other hand, I do not have the slightest doubt about the bright future of crypto.
Thank you for reading.