Concept Academic research results What it means for us
Disposition Effect Shefrin and Statman (1985) predicted that because people dislike incurring losses much more than they enjoy making gains (risk aversion), and people are willing to gamble in the domain of losses, investors will hold onto stocks that have lost value (relative to the reference point of their purchase) and will be eager to sell stocks that have risen in value. They called this the disposition effect. People will hold losing positions hoping that they can close them later at break-even or better. This is how support and resistance are born!
Representa-tiveness Heuristic People tend to make judgments in uncertain situations by looking for familiar patterns and assuming that future patterns will resemble past ones, often without sufficient consideration of the reasons for the pattern or the probability of the pattern repeating itself. This anomaly of human judgment, called the representative-ness heuristic, was demonstrated in a number of experiments by psychologists Tversky and Kahneman.
Related concept: Overconfidence - people place too much confidence in their own judgement (e.g. thinking they know the “truth” from observing one pattern 3 times), although it is not validated. • Key reason why people use Technical Analysis, and through self-fulfulling prophecy, it becomes relevant
• People get used to current market behavior, and through their actions support its continuation  leads to stable market regimes
• 2nd driver for support and resistance based on self-fulfilling prophecy
Anchoring & Conservatism
(leading to initial under-reaction to new information) Anchoring: Psychologists have documented that when people make quantitative estimates; their estimates may be heavily influenced by previous values of the item. In the absence of any solid information, past prices are likely to act as anchors for today's prices.
Conservatism bias means that investors are too slow (too conservative) in updating their beliefs in response to recent evidence. This means that they might initially underreact to news about a firm, so that prices will fully reflect new information only gradually. Such a bias would give rise to momentum/trends in stock market returns.
Related concepts: Framing (evaluating information influenced by the current “frame of mind”) & Cognitive Dissonance (assuming opposing facts/beliefs/concepts as true at the same time) • Prices can be "sticky", even if fundamental information implies a different value. Price adjustments start suddenly, once investor attention to new information reaches a critical level. This is how trends begin.
• Recent price ranges define the perceived "fair value" for many investors - once it is broken, it will catch their attention, causing them to reevaluate their position. This is the basis for dynamic break-outs!
Herding & Information Cascades
(leading even-tually to over-reaction to information) Herding: The behavior, although individually rational (if others follow the trend, I should do so to profit from it), produces group behavior that is, in a well-defined sense, irrational. This herdlike behavior is said to arise from an information cascade.
Information Cascade: The role of news events in affecting the market seems often to be delayed, and to have the effect of setting in motion a sequence of public attentions. These attentions may be to images or stories, or to facts that may already have been well known. The facts may previously have been ignored or judged inconsequential, but they can attain newfound prominence in the wake of breaking news. These sequences of attention may be called cascades, as one focus of attention leads to attention to another, and then another.
This process can lead to an overreaction to an otherwise valid fundamental catalyst. • Information Cascades & Herding are the mass-psychological process behind long-lasting, stable trends
• In the end, the self-fulfilling prophecy leads to an unsustainable one-sidedness of investor sentiment and positioning. Violent reversals follow  basis for contrarian strategies
Liquidity black hole: when herding pushes prices across loss limits for investors on the other side of the trade  blow-off move & capitulation Traders with short horizons and privately known loss limits interact in a market for a risky asset. Risk-averse, long horizon traders generate a downward sloping residual demand curve that faces the short-horizon traders. When the price falls close to the stop-loss limits of the short horizon traders, selling of the risky asset by any trader increases the incentives for others to sell. Sales become mutually reinforcing among the short term traders, and payoffs analogous to a bank run are generated. Short horizon traders sell because others sell. (Morris & Shin 2004)
Related concept: Liquidity premium (the econonomic compensation to provide liquidity to the market) tends to rise in volatile / stretched markets with lots of investor uncertainty There are short periods in the market where actions of market participants create a very powerful self-reinforcing short-term trend. The situation is not sustainable: when the last forced liquididation has been triggered, there is no one left to continue it, triggering a reversal at least. The sudden change in trend and the motivation of stopped-out traders to jump back in can trigger a powerful trend in the opposite direction of the liquidity black hole.