Last updated October 10th, 2018.
There’s often little logic in the movements of the market.
Why? It’s because stocks move at the whim of human beings who are often illogical themselves and driven by emotions. With as many technical and fundamental analyses done on equities, one their most important influences is psychology.
Realizing this can help you learn how to invest better.
Psychology is a vital, but under-appreciated element of stock trading. This is because most analysts are more mathematically focused. However, those who ignore the human and social aspect of the market are making a serious mistake.
Four different emotions cause most bad investment decisions. These are greed, fear, hope, and regret.
Greed is the desire for money and wealth. When a trader experiences greed, they are only able to think about how much money they have made from a stock and how much more they can make by keeping their position.
The problem? Profit is not realized until after a position is closed. Until this happens, a trader only has the potential for profit.
Greed can make an investor hold a stock longer than they should, hoping to make more money… until it plummets.
Fear, which is probably the strongest of all human emotions, causes a trader to sell a position regardless of its price. Unlike other emotions, fear is a survival response.
The Dow Jones Industrial Average (DJIA) in the U.S. took from 1983 until 2007 (24 years) to grow from 1,000 to 14,200, but it only took two years to lose 50% of its value (2007-2009). That’s the power of fear.
Fear is beneficial if it gets you out of a poor trade. Yet it can be even more dangerous when causing investors to not buy a stock which would otherwise be profitable.
Hope, a feeling of expectation and desire, is probably the second worst emotion for investors. It’s what keeps a trader in an unprofitable position.
When a losing stock decides to go up, investors will often stay in the “hope” of recouping past losses. That’s dangerous because the market will do what it does regardless of your wishes.
Regret is a feeling of disappointment over something which happened. It can cause a loss of focus.
It’s natural to regret making a bad trade or missing a good one. But an investor must simply learn from what went wrong and move to the next opportunity. That’s the only way to ever learn how to invest better.
The cycle of investor psychology.
Market psychology can be a very powerful tool. Traders usually just wonder if they should buy or sell a stock. Instead, you should ask yourself “what are others doing?”.
Becoming a smarter investor and learning how not to follow the herd will help you succeed in Asia’s emerging economies.
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