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Investing Basics
Keeping Your Emotions in Check
by David Dosik (Write for us!)
(Click on the links within the article to get definition of that word)
The biggest obstacle in making good investmentdecisions is probably our emotions. Numerous studies over
the years have found that investors have certain psychological biases that get in the way of making purely rational decisions.
We look for patterns in life, even when they don't exist.
Thus when the market is going up, we think it will continue on that track indefinitely and continue to invest as the market gets higher and higher When the market is going down, we fear it will continue to do so forever and avoid investing, even when process are attractive. This causes investors to buyhigh and selllow, the opposite of what they should be doing.
We would rather avoid losses than obtain gains.
Thus, we tend to hold on to stocks with losses for an inordinate amount of time, hoping the stock will get back to breakeven so we won't have to admit we lost money. On the other hand, we tend to sell investments with gains too quickly, so we can lock in those gains.
We become more risk tolerant when
we have gains on investments.
As those gains disapear, however, investors become more risk averse because their principal is at risk. This can lead to selling when investments are at market lows.
During the bull market of the 1990's, many investors believed their gains were a result of their keen investment savvy, rather than a result of the overall rise in the market. But as the market started to decline those same investors often blamed factors outside their control, which led to inaction.
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