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The Auction Mentality
Have you ever gone shopping on eBay? Perhaps you were bidding on a watch or a piece of clothing. You read the description carefully: "Gold Rolex. Looks New." What is the watch worth to you? You read further and the description says, "Broken watchband. Scratched crystal." Now how much is the watch worth? Much less, right? Well, maybe. Who knows? The watch is worth whatever someone will pay for it. Some people will not read the description closely and assume the watch is in mint condition. They may pay more for the watch than it is worth.
Other people work under the assumption that they absolutely must win, and they will irrationally pay more than it is worth just to win and relish the euphoria of winning. The unfortunate fact is that the value of an item auctioned on eBay is relative. Sometimes putting an item up for bid reveals its "true" value. For example, you may think your 20-year old Apple computer is a treasure, until you find out there are hundreds of them out there and that you can't give it away. (It's common to see sellers ask an outrageous price for a relatively worthless object because they wrongly believe that their precious item is valuable.)
The marketplace can reveal a lot about the value of an item, but it can also create a social dynamic that overvalues an object. People are human and may allow their perceptions and emotions to bias their decisions. These irrational biases can influence trading decisions as well.
Humans can be very sentimental. Have you ever lost a precious air loom? Maybe you accidentally broke your favorite toy as a child, and when you see it on eBay years later in pristine condition, you lose your perspective and are willing to pay hundreds of dollars for it. Is it worth it? No. But to you, it has strong sentimental value and you must have it. At that point, you'll pay anything. (Don't believe me? Look at the muscle car market. During the dot-com boom old cars were going for thousands of dollars more than what they could fetch today.) When we want something, we will do anything to get it. It is just not rational.
This can happen when trading the markets. You can start believing that a stock is worth more than what most market participants would ever pay. The stock may have sentimental value, and this may impact your judgment. About 30 years ago, for example, General Motors was one of the largest companies in the world. It's hard to believe that it is not undervalued these days. Your sentimental gut instinct may make you over-value a stock. But who knows? Maybe the halcyon days of the U.S. automakers are over.
It's hard to know what the future value of any company will be. It's all a matter of supply and demand as defined by infallible, fickle people. Hewlett Packard used to make superior electronic calibration equipment. Today they tend to make a lot of profit selling printer ink. Times may have changed. The point is that since public opinion matters in determining price, and the masses may throw fundamentals out the window, trading the markets is subjective and prone to market sentiment. It's essential to acknowledge this fact and account for it in your trading plans.
Sometimes market participants just get it wrong. They believe media hype or they may follow the crowd for no good reason. The auction mentality can take over and bias decisions. You can be on the right side of the trade, and profit. But on the other hand, you can be on the wrong side of the trade and lose. It's vital to always remember that the market action is based on the feelings and opinions of people, and people are fallible. They can be wrong. They can change their mind on a whim. This creates a constant state of uncertainty. If you can profit from it, you'll win overall. But if you fail to acknowledge the inherent chaos, you may regret it.
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I believe you are probably the best out of the literal hundreds of traders that I have witnessed.
