How many times have you bought an overvalued stock just because it was “popular”?
How many times have you held one too long, even though it was losing you money?
How many times have you looked at past investments and thought to yourself: “Gosh, how could I have been so stupid?”
I know I have… even though it pains me to admit it.
Looking back, I can see that many mistakes I’ve made have been because I couldn’t control my emotions.
I learned this lesson the hard way… as I know so many other investors have.
Edwin Lefèvre was probably the first to speak about the risks of allowing your emotions to get in the way of your investment decisions when he wrote “Reminiscences of a Stock Operator” (a great book and a must-read for any investor) back in 1923.
As Lefèvre explains, “The speculator’s four deadly enemies are: Ignorance, Greed, Fear, and Hope…”
The Four Riders Of The Investment Apocalypse
Let’s start with Greed, not because it’s one of the seven deadly sins, but because it’s the reason many begin investing in the first place.
The most common mistake novice investors make is chasing the market. They see a stock move up, and, because they’re greedy, they buy it when it is already overvalued… only to have to watch it fall back to its fair price.
Moreover, if you’re in a winning trade, greed can prevent you from taking profits when you should, because you’re holding out until the stock moves even higher.
On the other side of Greed, there is Fear.
It’s an even more powerful emotion because fear is a survival response.
When afraid, you might sell your position because of a sudden price move, not realizing that it’s probably temporary. Fear can also cause you to panic, resulting in even more severe losses.
Finally, after having a bad experience, fear can keep you out of the market entirely, which, again, prevents you from profiting.
Then there is Hope, the most dangerous investing emotion of them all.
Like fear, hope is a survival response. It motivates you to fight. However, hope also keeps you in a losing trade long after you should have exited. During every downward swing, you’ll be looking for a turnaround, hoping to recuperate your losses.
Unfortunately, the stock market is not a charity, and it could not care less about your wishes. Rest assured, if you’re hoping for your losing trade to become profitable, it’s already too late, and the market will punish you by taking even more of your money.
Finally, there is Ignorance, the emotion hardest to conquer.
Our biology has programmed us to avoid discomfort. It represents danger… and that’s precisely how, big picture, most people interpret the stock market.
Fight ignorance of the markets by doing the hard work of understanding the fundamentals behind any investment you’re considering.
And then face the reality of your losses. You can’t learn from your mistakes if you don’t admit them.
A Simple Fix To Kick Emotion Out Of Your Investing Decisions
The first concept to understand on your path to becoming a successful investor is that you have zero power over the stock movements… but 100% control over your emotions.
The market will always test you. Your challenge is to keep your emotions in check and to respond reasonably.
One simple but effective strategy can be to put time between a market event and your response.
Go for a jog or a swim… play a round of tennis or squash… maybe take a walk. Give your mind a chance to clear. Only then will you be able to get your emotions under control.
You cannot insulate yourself from losing trades. They’re going to happen. One key to becoming a successful investor is conditioning yourself to learn from your losing positions and move on quickly. There will be other opportunities.
It helps if you have a financial plan. Know why you are investing. Define your long-term goals. Write them down. Post them on the refrigerator or make them the background screen for your laptop.
Make sure your objectives are visible and unavoidable when you need them so your investment decisions won’t be emotional but rational… made because they fit your plan.