Trading without Cheers, Jeers and Tears

(eToro Blog)  Emotional investing can put a swift and painful end to any trader’s foray into the global financial markets. Numerous studies have shown that investors’ psyche tends to overwhelm their rational thinking during stressful times, regardless of the trigger. Traders often experience bouts of remorse as a result of their overreaction to a potential loss of their money.

During bull markets, new traders tend to have pay closer attention to others’ success stories and envision their own accounts growing larger by the day. Conversely, bear markets will draw out the most pessimistic tendencies. In the case of the former, traders might be compelled to get into the markets without weighing all of the facts and in the case of the latter, may sell off without due consideration. What inexperienced traders don’t realize is that the bull market and bear market designation is generally “old” news and getting in ahead of the trend is then an impossibility; their only hope is to ride out the trend and get off before it reverses.

Analysts have also noted that volatility plays a large part in building up an emotional response to the markets; during periods of high volatility a trader is statistically more likely to lose money. The most successful traders will tell you that what is critical to capital preservation and growth is the avoidance of elation, fear and gut-wrenching turmoil.

One strategy to avoid emotional trading is to use a dollar-cost averaging of your investment funds. In this strategy, a pre-determined and equal amount of funds is invested regularly into the same investment vehicle, then again and again at a pre-determined interval. In a downtrend, you will be purchasing your shares more cheaply, and in an uptrend your existing shares will produce capital gains even as fewer shares are added.

Portfolio diversification will also help to minimize your emotional response as markets don’t move in unison as frequently as you’d imagine. Diversification during a normal market cycle helps to provide some downward protection, and diversification can be as different as an investment type, industry, or even a different geographical region. Distinct market conditions favor certain sub-sectors within a market and a diverse portfolio which incorporates all of the various investment vehicles should provide some protection.

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