By Justin Zacks, Vice President of Strategy at Moomoo Technologies Inc.
Historically, investing in stocks has typically produced returns that have outpaced inflation and other investments, such as bonds, over a long-term timeframe. Stocks rarely follow a straight path through, and the market has been known to fluctuate. That is especially true now—as evidenced by the recent volatility. It is easy to get emotional and react quickly without applying the proper amount of thought and analysis when the market changes to protect or enhance our investments.
So how do we stop ourselves from overreacting to these market fluctuations and remove our emotions from the investing process?
Why do traders get emotional?
Like any stressful or frightening event, these market fluctuations may invoke our fight or flight response – driving us to make immediate, reactionary investment decisions. This is an understandable response, particularly when there is a lot riding on these financial decisions. When this biological response is triggered, it invites stronger emotions, especially fear and greed.
For example, when the market dips, there is an immediate spike of fear for investors. What does this dip mean for my portfolio? How long will this dip last? What can I do to counteract the dip? In the same way, when the market jumps up, an investor’s first response might be related to greed. How can I capitalize on this jump? What can I do to secure the highest level of profit from this spike? Greed also brings the feeling of FOMO, or the fear of missing out, when seeing other investors’ portfolios soar. Investors want to make a profit, and do not want to miss out on a chance to improve their portfolios with the same trades others are making.
Identifying the biases related to emotional investing
When we deal with stress, our minds naturally develop mental “shortcuts” to help manage the incoming information. While there are many uses for these shortcuts in our everyday lives, they can interfere with objective decision-making while investing. Some of the common shortcuts we commonly encounter with investing are loss aversion, diagnosis bias, value attribution, and preconceived bias.
The first step to avoiding emotional investing is to recognize loss aversion. In the same way that you cannot dwell on a win, you should not dwell on a loss. Not every trade is going to be perfect, and losses will occur to even the most careful of traders.
It is also important to recognize diagnosis bias. Just because there are a lot of traders discussing buying or selling a stock does not mean that is the right decision for all investors. To make the most informed decisions, an investor should do their own research about stocks they are considering. Additionally, investors should consider their own personal short-term and long-term goals before reacting to any news.
In a similar vein, traders should look at commitment, value attribution, and preconceived biases. Investing advice is always evolving depending on the market conditions so do not just stick to what was previously recommended. Additionally, while there may be value in investing with logic that works for someone, always follow up on the thinking behind the decisions that others are making.
How to remove your emotions from investing
So how do you remove your emotions from investing? The first step is to recognize when you are playing into existing biases you might have. Another important gauge is to check how reactionary you are to market fluctuations – is it the fight or flight response kicking in?
Success rarely happens overnight, so allow yourself time for your portfolio to grow and find the groove of investing. Also keep in mind that people rarely mention the bad trades they have made. They will only talk about their successes, which makes it look like they are only doing well. Don’t compare your behind-the-scenes to someone else’s highlight reel.
On the flip side, also remember that just because your portfolio is doing well now does not mean that it will continue to do so. Accepting the fact that the market fluctuates and riding out the waves is important for keeping your emotions in check.
Once you’ve done that, you—and your portfolio—will both be able to sidestep anxiety and set a stronger strategy for success.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Image and article originally from www.nasdaq.com. Read the original article here.