6 Emotional Biases You Should Avoid When Investing in the Stock Market

By Chika

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Last Updated: February 25, 2022

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It is said that investing is 80% psychology and 20% skill.

Regardless of how disciplined we are, the risk of having our emotions becloud our financial decisions is always present. The stock market is an aggregation of human emotions which bring about mis-pricings in stock valuations due to perceived valuation in stocks. 

These mis-pricings also present an opportunity to the investor who has learned to master and rein in emotional biases. Though it is impossible to make a profit from all your trades and investments, there is a higher probability that you can make investment decisions that are colored by emotional biases.

 

6 Emotional Biases to Avoid When Making Investment Decisions

1. Falling in love 

Many people often allow their love for a stock, company, or the CEO to get in the way of their investment decisions.

It is okay to give a failing stock some leeway to redeem itself and make gains. But if its price keeps going downhill, you may want to reconsider your investment. You are investing in the stock to make money off it, not send your money to die.

If a stock is not giving you returns after an estimated timeframe, you may consider trimming your position to reduce your losses.  

 

2. Revenge trading

If you have lost money on a particular stock, do not engage in a quest for retributive investment.

Engaging in revenge trading is a wrong move which most certainly would compound your losses. Your investment decision is based on emotions rather than fundamentals or technicals which exposes you to market volatility. 

When you lose money in a particular trade or stock, step back and reflect on why you experienced losses and what went wrong. Make some points in your trade journal and what strategies you would use next time.

However, always remember that you are trading/investing to make a profit, not to prove a point.

 

3. Regret

You have to know when to cut your losses and move on.

The most successful investors are those that have lost the most. See each unprofitable trade as a learning curve and use it to better your further trades or investments. Regretting merely wastes your time or energy, which should be channeled to other productive endeavors. 

 

4. Greed

There is always an atom of greed in every investor.

Nobody would refuse extra percentage points on a stock. However, if you let the train run too far, you may find yourself holding the bag. You should have a profit target in mind when you take a position in any stock.

Give yourself a price target and stick to it. If you feel that the stock still has some room to run, you can trim your position, while observing. Alternatively, you can use portfolio composition to determine how to trim your position.

For example, if you use a 2% equal weight composition for your portfolio, once a stock exceeds 2% of your portfolio, you can trim your position and move the funds to other less performing areas of your portfolio.

 

5. FOMO

The fear of missing out (FOMO) makes many people jump into investments and take a huge punch in the face for it.

When the ovation is loudest, it's best to bow out, stay low and observe. Do not buy a stock because everyone on social media is trumpeting it, chances are it is getting to its peak and will soon experience a drawback.

If you are a trader, wait for a price decline and confirm entry and exit points from your technicals before taking a position. If you're an investor, then the necessity of due diligence cannot be. Make sure you conduct due diligence before making a decision. 

 

6. Overconfidence

Never get lackluster in the stock market.

It is wrong to assume that you know it all. Doing so means you can predict the future accurately. Though you can use technicals and fundamentals to forecast the direction of a stock, always assume this is short-term and constantly review your thesis on the stock.

Also, macroeconomic factors such as a change in government policy, consumer tastes, social unrest could have a significant impact on the price or value of a stock. 

 

Get Ahead of Emotional Biases in Investing

The best way to avoid the pitfalls of human emotion is to set trading rules and adhere to them.

If you have a set target in a stock, stick to it regardless of profit or gain. Back your decisions with data and research and not emotions or attention from media or influencers.

Your choices may not be perfect at first, but the ability to learn from your mistakes would improve your skills and make you a better investor. Developing a contrarian philosophy will enable you to numb the noise and avoid knee-jerk investment decisions.

Photo by Anna Shvets from Pexels

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