Investment based on behavioural impulses, gut feelings, or emotion can negatively impact your returns. Commonly known as emotional investing, four primary feelings often govern the decision-making process: fear, greed, impatience, and excitement.
In turn, this can be detrimental to your investment portfolio, by allowing unreliable, phycological factors to cloud your judgement and blur your long-term lens.
To prevent these emotions from impacting your investment decisions, traders must learn to take a rational approach – overcoming the emotional impact of market volatility and doing research into the fundamentals of a company before coming to a final decision. Not only this, individuals must learn to spot the signs of emotional-trading traps.
It is perfectly normal to feel a sense of euphoria or fear when your money is on the line. However, learning how to manage these feelings in a calm, rational, and well thought out manner will mean the difference between success and failure for many investors. After all, investment can be costly, and it is important for you to learn how to get it right.
In light of this, below I have listed my top tips for investors looking to control their emotions while making important financial decisions, as well as the common pitfalls to avoid.
Identify the cause of your investment mistakes
The main problem is emotion, which often leads to weak or negative results based on gut feelings rather than data-driven research. Take the so-called trap of over-attachment to an asset as an example.
If you think of a certain company as successful, you may be overconfident that its stock is a good bet. This bias may be completely wrong in the current situation or at some point in the future.
To avoid this trap, it is important you remain flexible in your thinking, and understand the reality that any company can be extremely successful today and have problems tomorrow.
It is also worth noting the concept of FOMO (fear of missing out), which can often impact a short-term decision and damage your long-term gains.
Formulate new trading strategies
By coming up with better strategies to manage the overall investment process, not only will you maintain a more rational mindset, but it can also be an interesting and profitable way to get out of an emotional trading rut.
In fact, learning a new instrument can help you look at the market from a slightly different angle, with a fresher, calmer perspective.
Take time to do your research
Always remember that you are buying part of a company and not the hype. As such, it is important for investors to research the market or an individual stock before coming to a final decision.
If you make a concentrated effort to learn the fundamental side of a business, you can dive back into trading with a more objective mindset.
Don’t let your ego cloud your judgement
The best traders are not reckless or overconfident gamblers who invest their money on a whim. Moreover, learning the complex system of markets is not simply a one-step process.
Many investors have lost fortunes believing that they are better than everyone else. It is therefore imperative to not let your ego cloud your judgement.
Always keep a plan in mind
Finally, putting a plan in place will help you to manage your emotions and, in turn, reach your long-term goals. Don't let the results of a few trades change your strategy.
Stick to what you have learned and planned, use a trading journal, track trades and do your homework, and work on mistakes to develop your next steps.
Ultimately, a rational, realistic, and strategic approach is essential in trading. Not only does it build investor confidence, but it also helps to ensure that traders stay firm during price fluctuations and market volatility.
For those looking to increase their returns, spot the signs of emotional investing and take the time to put a tactical plan together.
Maxim Manturov is head of research at Freedom Finance Europe. The views expressed above are his own and should not be taken as investment advice.