Have you heard of the psychological concept called classical conditioning? It was first defined by Ivan Pavlov as unconscious or automatic learning. For traders, classical conditioning can be both a blessing and a curse.
It’s a blessing, because it means you’re ready to jump quickly into the action. You see a pattern forming on the chart, the indicators lining up, and price action confirmed. You know what to do – make that trade.
And therein lies the rub. Classical conditioning can be a curse, because you can fall into a routine or mindset that is difficult to alter when the market conditions change.
You can see this concept play out all around you. Take the Tour de France. Competitors might spend the first few days riding in beautiful sunny weather. Then the rain moves in. They have to change their mindset and braking and acceleration strategy, or they could end up losing valuable time.
Here’s what that looks like in real life:
Recently, markets have been riding high. The Nasdaq looked ready to break records in 2023 for outstanding gains in a one-year period with 60% more up sessions than down. Further, the Nasdaq has only had one major dip this year from February to mid-March. Since then, every pullback has been short and shallow.
The Nasdaq has been conditioning you to buy the dips, because that appears to be the only way to get on board when market momentum is strong and bullish. But this can be dangerous, because we do not know how long this pattern will last.
Once the market conditions you to expect the same behaviors to occur, a pattern change can be hard to see coming. The true downside is not knowing when to change your behavior. You’ve been conditioned to buy the dips. It should work every time. When it stops working, can you swiftly change your automatic behavior?
