Investors sometimes can act irrational. They sell when they need to keep or buy when it’s better to wait a little and buy later. Why does it happend? Because of emotions. They are the ones who push investors into irrational decisions. In this article, we will understand where the roots of impulsive trades grow and how to control them.
The connection between emotions and investments was firstly studied by Richard Thaler. He argues that momentary temptations carry more weight in decision-making than long-term goals.
How do investors get trapped in emotions?
Let’s imagine the following situation. The investor has acquired several shares of the popular company. He has a strategy and a specific financial goal, according to which he must sell securities at least in a year.
A month later, media share news that the partner of the company whose stocks the investor bought has gone bankrupt. Rumor has it that the organization itself is on the decline.
The investor is shocked. He falls into denial, then into aggression and disappointment. Instead of taking another look at his strategy or researching reliable sources, he logs into his personal account. And he sells all the shares of this company.
A few weeks later, it turns out that the firm is doing well. And the share price even went up 50%. This situation is very real. Almost all novice investors and traders at least once followed an inner voice.
“What if you burn out?” “And if now the quotes fall, and you go at a loss?”. “Buy other stocks, now Coca-Cola is in the black.” These brain tricks push investors into irrational decisions that get in the way of effective investment.
Immunity to emotional transactions
The only rival of the investor in trading is himself. Often not even large-scale events bring losses. For example, the US presidential election or a pandemic. And impulsive decisions. The biggest losses occur due to the investor’s overconfidence in his righteousness. When he sees that the quotes are suddenly falling down, panic begins. And then the investor sees nothing but a solid idea to sell the securities.
For example, in 2012, investors bought Facebook shares at an IPO for $ 38. Within four months, they were scared that the company would not be able to monetize mobile ads. Then the investors sold the assets for $ 18. And now Facebook shares are worth $ 174.
The same goes for buying. Newbies often succumb to upbeat news like, “Tesla stock has never reached this value.” And they run to buy them under the pretext: “What if they grow up again?” While experienced traders sell them.
Why do experienced stock market participants not go with emotions? Over time, they develop a kind of immunity. Emotions no longer take over their minds. And traders, like robots, act automatically.
Who is guilty?
There are three main emotions that prevent an investor from making rational decisions.
• Greed. It forces you to be led on “profitable” offers of the type: “Invest $ 100 and withdraw $ 1000”. The investor wants to give less and take more. But this does not work on a real stock exchange.
• Self-confidence. When an investor sees bad news, he begins to unreasonably make his own predictions. It seems to him that the situation will only get worse in the future. Moreover, he does not perceive the opinion of analysts, because self-confidence works in tandem with fear.
• Fear. The trader’s most insidious rival. It is he who makes you sell assets at the very bottom and blocks the road to the coveted profit.
But there are other emotions that can lead to a loss.
Sometimes sincere joy for a friend who has multiplied capital can turn into dark envy. This emotion can also push you to commit rash actions. For example, some investors try to copy the trades of successful traders on their own. They look for information about their strategies in the media, fish for information on personal profiles on social networks.
In fact, there is even a special term – copy-trading. This is an investment that involves copying the transactions of other traders. But for professional copy-trading, special platforms are used – services for copying transactions.
Over-optimism can also hinder investment success. Believing in the best is wonderful. But not when it comes to trading the stock market. In this case, hope only hurts, as it inflates expectations and forces you to take too much risk. Be careful not to turn optimism into high expectations.
Another enemy of the investor is anger. It makes you think irrationally and impulsively. Michael Weiss says that “anger raises a person’s ego above investment judgment.” Hot temper is not appreciated in investing. Here the winner is the one who acts with a cold mind.
Consider specific decisions that an investor can make under the influence of emotion.
• Sell off assets when the market falls. As a result, he will either not earn or go at a loss.
• Buy or sell assets due to news. Analytics are useful for every stock market player. However, you should not immediately make serious decisions based on the news that just came out. In addition, caution should be exercised when relying on analysts’ opinions.
How to avoid emotional deals?
1. Entrust money to specialists.
This is the easiest way to avoid emotional investing. You can trust the funds to professionals who, over the years, have probably developed immunity to impulse purchases.
Even professionals are thinking about how to reduce the risk of emotional investing. Therefore, investment organizations competently distribute tasks and responsibilities. Some people write a strategy, other specialists make an investment decision, and still others execute it. You can use wealth management services from some fintech projects, for example, Dutch Rate, UBS or Morgan Stanley.
2. Ignore noise.
Another option is to use the services of an investment analyst. Choose a competent specialist based on his professional achievements and the recommendations of friends. And follow only his recommendations. Alternatively, opt for a specific platform where analytical materials are published.
3. Selectively compose a portfolio.
In order not to worry once again, the investor must diversify the portfolio in terms of instruments and in time, as well as periodically revise the ratio of conservative and aggressive instruments.
For example, you have 50.000 dollars. It will be best divided into four parts. The first part is recommended to be invested now. The second in a month. And so on according to the given algorithm. Thus, the likelihood of making impulsive decisions will decrease several times.
4. Do not invest borrowed funds.
Many investors want everything at once and more. Some even resort to loans. In no case you should invest borrowed funds. You cannot predict the profitability. And you will have to pay for a long time.
5. Set realistic goals.
For example: “In 7 years I need $ 28,000 for a child’s higher education.” This way you can select the most effective investment instruments with acceptable risks. If you have a clear and achievable goal in front of you, no amount of emotion will lead you astray.
Thus, investors often suffer losses through their own fault. Of course, there are falls in the market, companies are experiencing financial difficulties. But these events are completely normal. This is not a reason to immediately sell securities. You just need to be patient, ignore external noise and obsessive thoughts. Particularly impulsive investors can turn to investment companies. Keep calm and don’t forget to share the article on social media.