I Plead Guilty To Being An Emotional Human Being 1
I have to admit, I don’t have the best ‘education’ when it comes to doing investments. I didn’t grow up in a family, that taught me all about finance, and even during my education International Business Management, investments and the stock market wasn’t dealt with in great detail.
I did my first investment in 1998… or rather speculation, when I bought an option in a company, which later appeared to have falsified its bookkeeping; and thus they went bankrupt. I didn’t touch investments for a few years. Then I learned a bit more about fundamental analysis, and I thought I got it… I learned about technical analysis, and I had thought I had understood it.
But it’s when I started reading about behavioral finance, that kind of opened my eyes. I realized that everything I had done wrong, and my losses were more the result of submitting to my emotions rather than bad analysis. I want to deal with three of these typical emotions, and how they can ruin virtually any potentially good investment.
Information Bias
One of the main problems, is that people are very subjective beings. I always found it strange that for some reason I found a lot of proof, supporting my belief about a particular stock, bond, or mutual fund. Then, it didn’t work out as it was supposed to, I panicked, and suddenly I found tons of material, supporting the opposite.
Information bias is a distortion in the perception of human beings. If we have an opinion of something, we unconsciously search for information that supports this opinion, or it seems to be dominantly present. As such, we may make wrong decisions. Information bias often exists since people want to go with the flow, or the masses. Not going with the masses might mean making a fool of yourself, or being put off as ridiculous.
Selling too early, selling too late
Being successful in the stock market often means limiting potential losses and letting profits rise. At some times, I have been guilty of doing the exact opposite: selling very early with a small profit, but selling much too late, letting my losses be driven up.
Relating to stocks, we often become very excited at small changes, and the bigger the change, the more relaxed we get. Therefore, many people tend to sell early at a small profit, being euphoric that they made a profit and fearing that they might lose it. On the other side, these people might become scared at having a small loss, hoping that the stock will recover. If this does not happen, often people tend to think that it would be useless to sell the stock now anyway, and the further the stock falls, the less emotional and involved they become. It is not unusual, that these people sell the stock at exactly the least beneficial point: when it has reached its bottom.
Making up for losses
Luckily I have been largely able to control this. However, many people want to make up for their losses, just as quickly as they occurred. This is very difficult, since a 50% loss requires a 100% profit to make up for it. Many people are willing to take more risks, and invest more money after they have lost some, just to make up for it. Some go bankrupt in their attempts.
I know I have a lot to learn, and I will certainly get more into this topic and write about it occasionally. Until then, I can recommend the following articles I found, which I find worth reading:
- Portfolio Management: The Pitfalls of Behavioral Finance
- Behavioral finance to the rescue?
- Why Smart People Make Big Money Mistakes (and How to Correct Them)
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- The Benefits Of Periodical And Automatic Investing In Mutual Funds
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