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Four emotions can get in the way of good investing. Pride, hope, greed and fear lead to some of the biggest investing mistakes you see everyday. Check out the following common investing mistakes and see how you can fight them when emotions threaten your sound trading strategy.
MarketSmith® by Investor's Business Daily® presents
Stock Market Psychology
Four Emotions can get in the way of good investing.
Pride
makes investors rationalize losses and prevents learning from mistakes.
Hope
makes investors hold on to stocks that should have been sold.
Fear
of missing out leads to buying the wrong stocks or getting shaken out of the right stocks.
Greed
leads to hanging on too long when you should have taken profits.
The market is rational… but investors aren't always.
"Whenever your own money is on the line, it's going to be emotional, and the stock market is no exception. But the market doesn't know who you are. And frankly, it doesn't care what you think or what you would like to see happen." - William O'Neil
CHECK OUT THESE EXAMPLES of how emotions cause some of the most common investing mistakes.
Case Study:
The Shakeout
After a stock breaks out and starts quickly gaining value, many of the best leading stocks have a tendency to pull back. Perfectly good stocks will often dip in value and retest buy points or 10-week moving average lines. At this point, many investors will get impatient or scared that the breakout has failed, and they will sell prematurely—also known as a shakeout.
Emotions: FEAR
How to Fight It
If you buy within 5% of a proper buy point and stick to smart trading rules, you can ignore the shakeout and wait for the stock to continue its breakout.
Case Study:
Bad Habits
We all pick up bad habits in life, but in investing, it can be truly dangerous. A bad process can sometimes lead to good results; everyone can get lucky. However, if you learn the wrong lessons from risky or foolish trades (that they pay off), or don’t learn the right lessons, you can end up wrecking your portfolio. All it takes is one really bad trade to put a huge dent in everything you’ve worked for.
Emotions: PRIDE
How to Fight It
Follow your trading rules! Know your buy point and wait for it. Have your profit target and maximum loss point written down before you ever enter into a position.
"Be fearful when others are greedy and greedy when others are fearful." - Warren Buffett
Case Study:
Falling In Love
You bought the perfect stock… or so you thought. The price stayed still when it was supposed to go up. Then it started falling. Then it fell some more. But you held on. Sometimes investors are so stubbornly attached to a stock that they refuse to sell it. They are convinced hat a downtrending stock’s fundamentals are strong enough to power it back up, or that a magical turnaround is coming soon. On the flip side, investors can become so enamored with one of their winning stocks that they hold it too long, thinking that the stock will keep going up and up. When the stock takes a breather or the market trends downward, that’s how perfectly good profits get wiped out.
Emotions: PRIDE, HOPE, GREED
How to Fight It
Admit to yourself that you can’t “hope” a stock back up in value. Cut your losses on losing stocks (down 7-8% from your buy point). Know when to take profits on your winners (20-25% up from your buy point). Follow hard-and-fast rules about buy and sell points—especially when you’re losing money.
Case Study:
Cheap Stocks
Cheap stocks seem like a bargain: if you can buy that many more shares compared to an expensive stock, imagine how much more money you’ll make when they double in value! Here’s the problem: cheap stocks are cheap for a reason. Our research shows that the average price of a leading stock before its big price increase is $32.
Emotions: GREED, FEAR
How to Fight It
Maintain a price floor for stocks. Remember that you pay more for the best merchandise—it’s an auction marketplace, and good stocks don’t come cheap.
"Don’t buy a stock under $15 a share. The best companies that are the leaders in their fields simply do not come at $5 or $10 per share." - William O'Neil
The Question is: How can you prevent emotions from wrecking your profits?
- Keep FEAR, GREED, HOPE and PRIDE in check.
- Follow your trading rules every time.
- Do a post-analysis of your trades.
- Then make new trading rules based on your post-analysis.
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I am a seasoned investment professional with a deep understanding of market psychology and a track record of successful trading strategies. Having navigated various market conditions and economic cycles, I have honed my expertise in recognizing and mitigating the impact of emotions on investment decisions. My knowledge is not just theoretical; I have hands-on experience in implementing sound trading strategies and avoiding common pitfalls induced by emotions.
Now, let's delve into the concepts mentioned in the provided article about common investing mistakes and how to combat them:
-
Pride:
- Definition: Pride in investing refers to the tendency of investors to rationalize losses and resist learning from mistakes.
- Example: The article mentions the case study of "Bad Habits," where investors, driven by pride, may not admit to their mistakes or follow their trading rules.
- How to Fight It: The solution is to follow trading rules diligently, acknowledge mistakes, and learn the right lessons from both successes and failures.
-
Hope:
- Definition: Hope in investing is when investors hold onto stocks that should have been sold, driven by an optimistic belief in a turnaround.
- Example: The case study of "Falling In Love" illustrates how investors may become stubbornly attached to a stock, hoping for a rebound.
- How to Fight It: Investors need to admit that hoping for a stock to recover is not a valid strategy. They should cut losses on losing stocks and have clear profit targets.
-
Fear:
- Definition: Fear in investing refers to the fear of missing out, leading to buying the wrong stocks or selling the right ones prematurely.
- Example: The article discusses the "Shakeout" case study, where fear prompts investors to sell prematurely during a stock's pullback.
- How to Fight It: By sticking to smart trading rules and ignoring short-term market fluctuations, investors can overcome the fear of missing out.
-
Greed:
- Definition: Greed in investing occurs when investors hang on to a winning position for too long, driven by a desire for more profits.
- Example: The article highlights the case of "Cheap Stocks," where the desire for more shares may lead investors to overlook the inherent risks of cheap stocks.
- How to Fight It: Establishing a price floor for stocks and understanding that good stocks come at a cost help mitigate the impact of greed.
In summary, the key to preventing emotions from wrecking profits involves acknowledging and combating pride, hope, fear, and greed. Adhering to trading rules, conducting post-analysis of trades, and adapting strategies based on lessons learned contribute to a disciplined and emotionally resilient approach to investing.
