Emotional Investing, what is it? It is the extent your emotions affect your investment decisions.
Many people do not realize the impact of their emotions on their investing experiences. That is to say that they do not know that how they manage their emotions while taking decisions to some extent determine the level of their successes or failures as investors in the financial markets, particularly the stock market.
How do you know that you are an emotional investor?
- Do you celebrate unrealized profit? Jumping for joy over unrealized profit means you’re probably an emotional investor. Until you sell your stock and bank the capital appreciation, your profit exists only on paper.
- Are you fixated on stock news? Though keeping abreast of market news is good, but monitoring the stock market 24 hours a day is not healthy when you are not a broker or an employee of the financial services firm. This is a sure indication that you are an emotional investor.
- Do you fear stock updates? If you are addicted to checking stock updates because of fear of price decreases, you are likely an emotional investor.
- Do you sell your stocks if it falls by a few bucks? If you sell your stocks because it hurts you to lose a few penny, you’re an emotional investor.
- Do you make frequent calls to your broker? If you call your broker every 5 minutes during trading hours to check the value of your investment, you qualify as an emotional investor.
- The rational way to handle bad news about the stock market or a company you have invested in is to calculate the effects and make a decision accordingly. If you panic at the slightest hint of unfavourable news, you’re an emotional in
Do you panic over bad news? The rational way to handle bad news about the stock market or a company you have invested in is to calculate the effects and make a decision accordingly. If you panic at the slightest hint of unfavourable news, you’re an emotional investor.
If you answered yes to any of the questions above, you definitely are trapped in emotional investing.
Studies in behavioural economics have helped us understand that the stock market does not always behave in an analytical, logical and rational pattern. Emotions often play a predominant role in investment decisions. In other words, many trades are based on intuition and feelings. Thus, it will not be wrong to add emotional investing to the list of strategies investors adopt in playing the market like growth and income strategy, value investing, buy and hold amongst others.
According to modern psychology, emotion, behavior, and cognition influence each other and effectively define human motivation. Psychologists further identify basic emotions such as happiness, anger, fear, disgust, and surprise which when combined in different ways manifest in human behaviours such as rage, hunger, and even greed.
In investment decisions, emotions manifest in the form of greed and fear, anxiety, complacency. When any of these behavioral patterns are at play, the investor behaves irrationally. He is driven by impulses rather than by analytical thinking in his choices. Of all the emotions, the combination of fear and greed work together to impact negatively on the investor. He depends more on what the crowd is doing, what the news media is singing and the actions his friends are taking in making investment decisions.
The period preceding 2008 before the massive collapse of the Nigerian stock market saw a preponderance of emotional investing driven by greed. Many investors were attracted to the stock market during this period essentially because tgheir friends had told them how they were making fantastic returns.
Many did not define their investment objectives nor designed strategies for creating wealth through the stock market. They simply floated with the tide, running to sectors the crowd believed was profitable. It was a period penny stocks became preferred investment choices irrespective of the fundamentals of the companies. It was a period of get-rich-quick mentality when an investor would put a naira in a stock and expected to make 500% return in under two weeks.
It was a period of greed.
Fear can have just as much overwhelming impact on the financial market as greed. Fear manifests as an unpleasant, strong emotion and anticipation or awareness of danger. When stocks suffer large losses for a sustained period, the overall market can become more fearful of sustaining further losses. But being too fearful can be just as costly as being too greedy.
How do you identify an investment strategy blurred by emotions?
Essentially, emotional investing is not based on sound investment principles. The investor does not have any investment objective, he simply rides with the tide and bases his decisions on what currently obtains in the market without consideration of how such actions fit into his overall investment objectives.
He does not do any analysis of the stock before he buys. A rational investment decision is often preceded by some research. It begins with perusing the annual reports and accounts of the company you want to invest in. This will, at least, give you a general overview of the performance of the company in historical terms and a peep into its future.
As a result of moving with the tide or what has come to be known in the investment circle as a contagion effect, the investor more often than not time his entry into a stock wrongly. He enters either too late when stocks have become so overpriced and thereafter forced to exit at a loss as the market begins to correct.
Short term mentality is another feature that dominates emotional investment. The investor expects to reap attractive returns within the shortest possible time forgetting the fact that, by its nature, the stock market provides an opportunity for long-term capital accumulation.
A short-term investor very often fails to realize that income accretion in the form of dividends received over time and even the bonuses arising from holding stocks for a longer period all form part of returns on investment. To the emotional investor, price appreciation over a short period of time more than compensates the cost of investment.
How to overcome emotional investing
Savvy investors are disciplined and make investment choices based on sound principles developed over a long period of time, usually derived from experience. It must be emphasized that there is no one best strategy to investing in the stock market, disciplined investors adopt a combination of strategies.
- Invest for the long-term
- Understand what you are investing in
- Set definite goals
- Develop a strategy
- Do not panic in a downward trend
- Have an investment policy plan
- Think Rationally
- Diversify your portfolio
- Rebalance and do not be heavy in one asset class.
There is no doubt that making money can be an emotional matter but making investment decisions based on emotions rather than laid down principles of investment can negatively affect your decisions and the cost might be unquantifiable. So try as much as possible to remove emotions from making investment decisions.
One of the ways to detach your emotions from your investment decision-making process is to hire a professional investment advisor who understands the market and is positioned to offer unbiased professional guidance as you wade through the tidal wave.