When we start investing as amateurs, we often make it a habit of piling the new investments at the top and selling the ones from the bottom. Several investors, especially the new ones, get caught up in the 'hot stock tips' and start to make the worst buying and selling decisions possible. This is one of the biggest pitfalls of emotional investing and most of the time these investors find themselves deep down the gorges of depressive investment scams.
2018 is a time we can explain almost everything with the help of scientific experimentation, observation and reasoning. Investor behaviour is not an exception here. Over the decades, experts have documented investor behaviour and several riding theories explain the emotionally-charged decisions amateur traders make during buying and selling.
Why do investors become emotional?
The non-profession trader, who is investing his hard-earned cash in stocks and shares to make some extra money, wants to choose the 'sure shot' shares and minimize his losses at all costs. This is where things get a little clouded. He gets his stock information from financial news, online sites, friends and family. As a result, he enters the prolonged bull markets during the periods of low volatility.
A prevailing theory states that money flow for mutual funds is usually most responsible for raking in the highest amounts when the market hit the peak or the valley. The money flow continues until the market hits absolute bottom and that prompts the investors to pull the money out of the market. This causes the money flow to become negative. In most cases, the investors just fail to time their buy-sell processes to benefit their finances.
Between 2004 and 2007, during a strong bull market, investors showed a strong tendency to pour money into the market. This was just like the bull market of the 90s. This shows that investors are comfortable pouring in money during the periods of low volatility. However, the same study shows that during markets of high volatility, there is a distinct confusion amidst all amateur investors. The money flow represents a strong confusion among all candidates, and their actions do not correspond to the best times as per market tendencies.
Why should you never trade on emotion?
Trading on emotion has some cons. Even the most experienced trader sometimes falls prey to his emotions while making a buying/selling decision.
- Traders often buy a stock hoping it will rise in value. When it goes down, a huge percentage of them hold on to it just because they do not want to face the reality of the loss. This further exacerbates the monetary losses.
- Several traders buy stocks when they were at the highest possible market rates. They succumb to huge losses once the prices tumble.
- Amateur traders would rather save their ego than their pockets. They leave, but not before it is too late. This simply adds to the financial losses.
- They do not rely enough on trading software, desktop applications and factual evidence to make buying decisions. As per the National Australia Bank, traders who act on intuition and emotion are often worst hit by sudden market shifts.
How to eliminate excess emotion from the process?
Make the process more mechanical
Instead of fear, trepidation or ego getting in the way, you should always think of a reason. Buy when stock prices are low and sell when they are high. That sounds simple enough, right? However, it takes tens of mistakes for most amateur traders to figure this one out. Always choose the amount of investment based on your risk and return ratios.
The easiest way to achieve this –
- Always trade in the same amount.
- Always trade during the first few days of the month.
- Always pick roughly the same time of the day for completing your trades.
- Stick to the mechanics and do not make out-of-the-box decisions based on emotions.
These sound too simple to be true, but a lot of now successful traders have always followed these simple rules to begin their careers. The idea is to eliminate the emotions and the ego that causes us to incur more losses each time the stocks fall. Relying more on software, investing in small shares and sticking to low-risk investments are effective ways to make that happen.
The best quality of mechanical trading is the purging of emotion from the entire process. Therefore, even the most novice of all traders can easily make the right buying decision during the times when stock costs are low and sell when the stock prices start climbing. No matter which blog or website says that stocks are hot and you need to buy them, you should always listen to logic. When you make a mistake, simply admit it and move on. It is just like any other mistake you can make, so just cut the losses quickly and find new stocks that promise better returns.