Maxim Manturov, Head of Research at Freedom Finance Europe
Did you know that one of the biggest threats to your investments is you?
Commonly known as emotional investing, behavioral impulses and gut feelings can often rule your decision-making process. In turn, this can have a debilitating effect on your investment opportunities. Whilst you may believe that you are making a rational, wellthoughtout decision, unconscious influences such as cognitive biases may actually be working against you.
Some individuals are aware of this impact, however, ifa number of these influences affect our unconscious bias, how can we spot the signs?
With this in topicin mind, below I explore the impact of behavioral impulses on investments, as well as the top rational investment strategies that canhelp you to avoid the pitfalls of emotional investing.
The psychological dangers of investing
Firstly, we need to identify what it is that can cause investors to waiver when making important, financial decisions. For the most part, the main problem is emotion, which often leads to weak or negative results in the market. There is the so-called trap of over-attachment to an asset.For example, if you think of a certain company as successful, you may be overconfident that its stock is a good bet. This bias may be completely wrong in the current situation or at some point in the future, andcan lead to a negative return on investment.
To avoid this trap, you must remain flexible in your thinking and be open to new sources of information, while understanding the reality that any company can be extremely successful today and have problems tomorrow. It is also worth noting the concept of FOMO (fear of missing out), which is an emotional state seen when an asset shows solid growth and there is a significant desire to buy.This often happens when entry into a position occurs near the highs of a business’s performance,which does not necessarily justify the risks.
Once you have assessed the psychological dangers of investing, as well as the emotional-trading traps to avoid, there are a number of strategies and tips that canhelp you succeed. This includes taking a rational approach and doing your research before coming to a final decision.
- Learn a new trading strategy
This can be an interesting and profitable way to get out of an emotional trading rut, and learning a new instrument can help you look at the market from a slightly different angle, with a fresher perspective.
- Do some in-depth research
Take time to research the market or an individual stock.If you make a concentrated effort to learn the fundamental side, you can dive back into trading with a new perspective and gain confidence in your actions. Do not rely on gut feelings alone, nor should you rely on what one person is saying.
- Paper demo
Before trading a new strategy, it is best to test it in a paper (demo) account to understand all the vulnerabilities of this strategy and be ready for them in real trading. Practice does indeed make perfect, and this will also help you to spot emotional-trading traps more easily.
- Reduce ego in trading the markets
Many investors are overconfidentand think they know better than the experts or even the market. Just being well educated or smart does not mean you won’t benefit from good independent advice. It also doesn’t mean that you can outsmart the professionals and the complex system of markets. Many investors have lost fortunes believing that they are better than everyone else. Do not let your ego or greed cloud your judgement.
- Always keep a plan in mind
Putting a plan into play and including losses as part of this plan, as long as they do not exceed the norms of the trading system, should always be followed. Don’t let the results of a few trades change your overall strategy and approach. Stick to what you have learned and planned, use a trading journal, track trades and do your homework, and work on mistakes to develop your next steps. Applying a long-term lens will mean the difference between success and failure for many investors.
The benefits of rational investment
Adopting a rational, realistic, and strategic approach to investing is always vital. First and foremost, this will increase your likelihood of success, as a sober understanding of the situation is essential in trading. Moreover, treat trading as a personal business – if you treat your trading as a hobby and have no real goals, it will be difficult to make steady progress. Instead, write a business plan, list specific and achievable goals, and outline daily actions to keep your emotions out of the way. In fact, these systems will help remove emotion from the overall tradingprocess.
In working with clients, we often try to warn people against FOMO and other psychological traps, be it excessive euphoria or fear. And it is through our managers that we try to convey a fundamentally correct point of view in certain market situations. This helps to build investor confidence and ensures that traders stay firm during price fluctuations.