Behavioural Biases & Investor Psychology
The above fact is what makes the 10% of winning investors and traders immensely wealthy. The main reason most people who invest/trade in the markets lose money is psychology.
Whatever investment strategy an investor follows, irrespective of whether it is quantitatively or fundamentally driven, optimal returns are often illusive due to the pitfalls encountered during the process of investing that make taking disciplined decisions an almost impossible task. Exposing some of these pitfalls and becoming aware of their existence, is perhaps the first step in an effort to minimise the risk they pose towards rational decision-making.
Pride is probably one of the most common pitfalls investors tend to fall into, especially during bull markets such as the one we have been in since mid-2009. Pride is closely associated with overconfidence and having too much belief in your own ability to outperform. This situation breeds arrogance and complacency, ultimately leading to disaster. It’s probably best to remember if gains appear too good to be true, then they probably are and one might be best served by lightening up on their positions.
Envy is another pitfall that causes investors to behave irrationally during bull markets. Stories of fortunes made in the stock market during these times are in abundance and avoiding the noise can be hard. Pondering on these stories creates all sorts of emotional entanglements which end up clouding the mind and taking away the much needed objectivity required when making important investment decisions. To generate investment success it is best to focus on one’s own talents and strengths and invest in what you understand rather than following the investment strategies of others.
In the investing arena, too much of anything is typically a recipe for disaster and sleepless nights. While there are definitely positive results from effective diversification, portfolios with too many holdings are likely to disappoint. To avoid spreading yourself too thin in managing your investments, a disciplined approach to diversification is probably better than chasing around any flavour of the month stocks recommended by the talking heads on daytime financial channels.
Another common stock market pitfall is getting unhealthily and emotionally attached to your investments. After holding shares of a particular company for some time it is particularly easy to get attached to them – whether they are going up or down. This will most certainly affect your ability to evaluate your portfolio objectively and eventually lead to below average returns.
A common reaction to losing money is anger. Usually, it is vented off at someone else, as it is never our fault for having made a bad investment decision. The trend of blaming others for our misfortunes is certainly not a new one. If money is lost due to unsound decisions then it is more than likely that you should take responsibility for your actions which leads to acceptance rather than being in a state of denial of your own personal shortcomings when it comes to taking investment decisions.
While some greed is not necessarily bad when it comes down to investing, becoming too greedy can cause investors to pursue riskier investments than they would contemplate under normal circumstances. Aiming to consistently outperform the market is unrealistic and only sets the ground for frustration and disappointment. Keeping things simple by adopting a straightforward investment strategy and having modest aims will most likely serve you better, particularly during the early phases of investing.
There are no shortcuts to investing successfully. And this is by all means is no easy task, especially in the current environment. Being aware of some of the emotions you go through during the process of investing is certainly of some help. It is probably best to remember that investors who remain faithful to their long-term goals and strategies manage to avoid committing some of the above-mentioned biases that can erode portfolios and long-term wealth generation.
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