Understanding Our Emotions

Some people invest like Warren Buffett, calm and easy; others invest like a bull dog, simply “hit” whenever they listen to any rumours. Sad to say that, not everyone is fit to invest in the stock market. Majority of the investors plunge in by emotions at the wrong time and bail out by emotions at the wrong time. In general, stock market preys on fear and greed, and it’s not designed to reward the masses. Warren Buffett said, “Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market.”Let’s take a look at the following common mental mistakes, and see if you can handle them well:
1. Herd MentalityWe see this trait in the animal kingdom, such as a school of fish, a flock of birds, and a herd of sheep. Like the animals, we feel comfortable in doing things together – if more and more people are buying a particular stock, most likely we will follow suit if we happen to have some money in our pockets. The way to profit from this phenomenon is to resist the herd mentality and try to be a leader. In any crowd, or group behaviour situation, the ones that lead are the ones that draw all the benefits, while the ones that follow blindly are the ones that take all the risks.
2. Gambling Behaviour and SpeculationIt is believed that gambling behaviour and speculation are part of our human basic trait. Statistics showed that 1.1% of men and 0.5% of women are “probably compulsive gamblers”. In general, speculators often dictated by factors such as tips and rumours to take advantage in the stock market. This behaviour is usually unpredictable, short term and unwarranted.I would strongly advise genuine investors to avoid following the crowd blindly as it is always double edged situation – either huge profit or heavy losses.
3. Greed and FearThere are two cardinal sins: Greed and Fear, which are inherent in human beings. For instance, we bought some stocks and we are starting to make profits. Assuming we made a 50% profits in a particular stock, our greed will tell us not to sell, as we are hoping the price to go higher. However, it didn’t, instead it fell back to the original price. One month later, the price moved up by 10%, and our fears kicked in, spurring us to take profits. So without a proper strategy plan, we are blinded by our own emotions and instincts that prevented us from making the right decision.Hence, we should never let our emotions cloud our trading judgment. What we can do is to turn the crowd’s fear and greed to our advantage! To exploit the market psychology, we must act in a contrarian way when the crowd falls prey to their emotions.
4. OverconfidenceOverconfidence can cause investors to underestimate risks when investing in stocks. Studies have proved that investors who have recently earned high returns will tend to take more risks in their future investment (in stocks.) I’ve seen many of my friends who fall prey to this emotion. They initially made tens of thousands of dollars. However, due to overconfidence, they invested more heavily than before and they even tolerated with much higher PE ratios. As a result, they give away the gains back to the stock market!So, if you happen to have more than two of the above common mental mistakes, please put your money into reputable unit trust funds where you have professional portfolio managers to invest for you.