The key to being a successful investor is to be rational and stick with an investment strategy. This is because market cycles can trigger emotions and cause you to make poor decisions. The most emotional days are the correction and bear periods.
A bear market usually scares the most inexperienced investors. Having never experienced such a situation, they panic and abandon their investment strategy. If you have been investing for less than 1 year or so, you surfed the whole bull wave, and it just felt good, right? However, when the bear market period comes you never know when the market will swing up again, and it takes psychological and financial fortitude to ride out that storm. If you think about it, that fear itself is what causes the market to continue falling.
Rationality outplays emotions
Emotions can be very unhealthy and dangerous for an investor because they can lead to irrational decisions based on short-term pain, which causes you to lose sight of your strategic objectives and financial goals. Whether it’s fear, anxiety or euphoria, allowing emotions to play a role in investment decisions can be costly.
The most common emotional reaction is that investors either regret or overreact during times of stress, euphoria or panic. This is especially true of retail investors, who typically 𝐢𝐧𝐯𝐞𝐬𝐭 𝐭𝐡𝐞𝐢𝐫 𝐡𝐚𝐫𝐝-𝐞𝐚𝐫𝐧𝐞𝐝 𝐜𝐚𝐬𝐡 expecting a return just like every other investor on the planet. However, when their investments lose value during a correction or bear market, it can cause stress and panic.
The key is to take a rational approach to investing, similar to the unemotional approach of a professional portfolio manager. This mindset can be achieved with due diligence, a disciplined investment process and a sense of perspective.
“Doing well with money has a little to do with how smart you are and a lot to do with how you behave.”
– Morgan Housel, The Psychology of Money
Roller coaster of emotion
There is a common cyclical investment process with new or less experienced investors. Emotions are a great asset in our lives, but they can also be a major threat to our investing process. There’s the feeling of excitement whenever the market goes up, which quickly can turn to fear when the market goes down.
These are the most common feelings when investing:
This roller coaster of emotions and feelings can lead investors into costly mistakes. For example, buying at the market’s peak or selling just before the market rebounds. Before making a decision, leave your emotions on the side. Take a step back and think about why you are investing in the first place. This will ensure that you don’t let your emotions affect your investment decisions and help you stick to your strategy and plan.
Human psychology is a dangerous thing when investing, but it’s critical to refrain from repeating the same mistakes. Investing is a learning process. Even the most experienced and seasoned investor can learn something new.
Overconfidence and self-attribution
Do you know that feeling when you are so confident in a company or that the market will go up? When the plan goes well, you feel like you deserve all the credit, when the plan doesn’t go so well, you blame external factors.
That reaction is called overconfidence and self-attribution. You feel like you are above the average investor in a bull market and you tend to trust your gut more than anything. As forecasting the future is extremely difficult, it is wise to stick to rational thoughts relating to your investments. You can use your gut too, but don’t use it as a primary tool of investment.
Since there are no perfect investors, it’s also critical that we identify specific mistakes we’re making so that we can build a mechanism to prevent us from repeating these failures.
Tips to avoid emotion when investing
- Focus on the strategy: When you begin investing, it’s important to create an investment plan followed by a time-horizon goal. If you have the patience, a long-term vision is the optimal way to invest and easiest to stick with, and it prevents you from getting caught up in short-term traps.
- Ignore the media: Don’t follow the crowd, and stop watching what the media is saying. They tend to over-exaggerate, especially when the market is correcting or going down. Instead, look for other experienced investors’ opinions and always look for a bullish and bearish view on the situation.
- Diversification is important: Diversification will help you get through volatile times. Of course, there will be times when the entire market is going down, but the more frequent situation is when some sectors will be down and others won’t, which offsets the losses for the losers. Therefore, diversify your portfolio by investing in different types of assets and sectors (i.e. Stocks, Cryptos, ETF’s, Popular Investors).
- Dollar-cost averaging: This is the most underrated strategy that can produce positive results regardless of the market condition, especially in a downward trending market. Using DCA (dollar-cost averaging) enables you to buy shares at lower prices and, therefore, as the name says, you will be averaging your buying price. This means that once the market recovers, you will recover at a faster pace. When the market falls, view it as an opportunity to dollar-cost average your investment positions.
- Just be patient: You already know the saying “Investing is a marathon, not a sprint”, but really, this is true. The more you try to get rich quick, the greater the chance you will lose your money. Usually, the sprinter is emotional, so being consistent over time is extremely difficult. However, being an emotionally controlled marathoner will generate for you consistent and long-term returns.
Paulo Gabriel Sa is a popular investor on eToro. Paulo’s investment focus is stocks and crypto, and he looks to diversify his portfolio between growth and value stocks. Some of his interests include technology, innovation and renewables.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
Copy trading is a portfolio management service, provided by eToro (Europe) Ltd., which is authorised and regulated by the Cyprus Securities and Exchange Commission.