Investing psychology

 Everyone wants to be a great investor. And Why not? Investing is challenging, best way to have financial freedom and thereby live life the way we want to live. But market study has suggested that an average investor loses more money than he gains while doing investing or stock trading. Why does this happen? Does it have to do with technical knowledge like fundamental analysis, stochastic analysis, ability to reach charts diligently, knowledge of useful patterns, etc.

Well! Expert investors say quite contrary to this. According to them, an average investor remains average because he/she lacks the temperament, the character and above all lack the way successful investors think. It all boils down to psychology.

Behavioral psychologists have pointed many limitations which leads to error in our decision making process. Whenever we make decisions we have plenty of information available. But that information contains noise as well. Eliminating noise is quite important while doing investing. Noise include price fluctuations which makes it difficult to perceive what’s genuinely driving market forward. Noise traders are usually reactionary who base their decisions on trending news circulating in social media. They have tendency to think that every reaction in a trend is the beginning of a new trend. Always look for long-term results and avoid short-term gains.

Investing is speculative but a good investor tries to move away from mere guessing. He gives time and energy in understanding the company in which he decides to invest his hard earned money. Understanding company’s products, industry, customers, employees, management is his foremost task.

Loss aversion is a kind of behavior wherein investor prefer to avoid loss than making profit of same amount. Psychological impact of a loss is twice that of same amount of profit. This makes investors to hold on to loss making commodity even when there are better alternatives - thereby making more losses. Practicing detachment is crucial in coping with loss aversion behaviour.

Hindsight bias is an occurrence that makes investors believe that they accurately predicted an event after it happened. This leads to overconfidence which in turn allow investors to be in illusion that they can predict further events. Once we know the outcome, it is easier to create a plausible explanation for that event. We selectively remembers only the information which suits our conclusions and perceptions. We see things as we want to see and create a story which supports our arguments.

Good investors think about what other people are thinking because then they are able to know herd mentality. This allows them to avoid asset bubbles, panic buying and panic selling.

Herd psychology helped us to survive physically in our evolutionary journey but today it has more dangers than benefits, specifically in finance and investment. Now, our natural tendency is to move with crowd, with culture, and doing something contrary to it can bring fear of being lonely and fear of missing out (FOMO). Average investor succumbs to these fears to avoid subconscious pain.

“To follow the good principles and not let fear, greed and hope interfere with your trading is tough. You are swimming upstream against human nature.” - Richard Dennis

Often impatience and frustration leads an average investor to sell just because that share or stock is showing little progress. He is bored of slow progress. Other times, he clings to bad investments out of stubbornness. A seasoned investor understands the difference between greed and making profits. Greed let him act only when the bull market has passed entirely.

Sticking to simple routines appears easy but more than often mind falls for complicated. Not that these methodologies are not useful but the idea is to find simple routine which works for you and repeating it. Complication overwhelms the mind. Simple is not easy or boring.

“We could post our trading rules on the front page of the Wall Street Journal, and still people would not be able to make money from them” - Quote from an expert Investor

Expert investors will say this happens because of fear. Fear of being wrong, Fear of missing out, Fear of losing money, Fear of leaving money on the table. Constructively using mistakes and losses builds up emotional resilience which is the best bet for being a successful investor. Even good traders are only 50% correct in their decisions. Market cannot be predicted. Accept this fact as an investor. Embrace losses. No one can be fearless but the concept is to not let stimulus of fear override the rationality and intuition.

Charlie D’s counter intuitive advice - “The time you know you have become a good trader is that first day you were able to win by holding and adding to win positions. There are many people that have traded for a long time and who have never added to a winner.”

Rather than taking half-profits, 1% goes more deeper. ‘I am winning, So i am reducing my stake’ -Using this logic, normal investor tries to avoid subconscious pain. But such a decision is based on fear of not losing. Creative investor welcomes pain and disturbances through continuous feedback rather than settling permanently in a mediocre mindset.

Financial marker doesn’t work like a super-market. Bargaining is good when you are shopping in the super-market but bad mindset for gaining profits in financial market. Financial market is uncertain. Be ready to see unexpected in this business. As an investor, you also cannot predict the market heights, so it is better to not think in terms of boundaries. Example of this is bitcoin. It had such a tremendous rally and downfall of over 50 percent in recent times.

Let’s sum this up with key points.

Consistency and sustained focus

Be creative

Learn from mentors and great investors

Emotional endurance

Not settling down, always working to improve the game

Understanding mind as a whole.