Last updated October 7th, 2019.
Sometimes, there is surprisingly little logic in the stock market’s movements.
Why? It’s because stocks move at the whim of human beings who are often illogical themselves and driven by emotions.
Many types of technical and fundamental analyses are done on equities, financed by billions of dollars worth of hedge fund and investment banking money.
Yet psychology still remains one of the top influences on the global stock market. Realizing this fact can help you learn how to invest better.
Psychology is a vital, but underappreciated element of stock trading because analysts normally focus on mathematics and trends. However, anyone who ignores human and social aspects of the stock market are making a serious error.
Four different emotions cause the vast majority of investment mistakes – especially if you’re an individual stock trader.
Those four emotions are greed, fear, hope, and regret. Here’s why they will often lead to more losses in your portfolio than any other factors, including economic recessions.
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 you sell a stock, a trader only has the potential for profit.
Greed can make an investor hold stocks far longer than they should, hoping to achieve greater returns – until their asset plummets.
Learning how to invest better involves intuition and knowing when to quit while you’re ahead.
Fear, which is probably the strongest of all human emotions, causes a trader to sell a position regardless of its price. Unlike most other emotions, fear is a survival response.
The Dow Jones Industrial Average 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 about 50% of its value (2007-2009). That’s the immense power of fear.
Don’t get me wrong: fear is beneficial if it gets you out of a poor trade. Yet it can be dangerous when causing investors to not buy a stock that 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, regardless of your wishes, the market will do what it does.
A good investor should know when to cut their losses. Recognizing that you made a bad trade can bruise anyone’s ego. Regardless, it’s better to accept the learning experience and move on.
Regret is a feeling of disappointment over missed opportunities or a poor trade. This emotion can cause an overwhelming loss of focus.
Not all decisions are good ones, and feeling regret over them is natural. But an investor must simply learn from what went wrong and find another opportunity. That’s the only way to ever learn how to invest better.
The cycle of investor psychology. Sometimes, stock prices move like a rollercoaster… and so can emotions when your portfolio suddenly rises or drops in value.
Market psychology can be a very powerful tool. Traders usually just wonder if they should buy or sell a stock. Instead, consider asking yourself “what is everyone else doing?”.
Becoming wiser, and figuring out how not to follow the herd, will help you learn how to invest better. Your success across Asia’s emerging economies will depend on skill and intuition more so than number crunching.
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