Advanced imaging technology allows you to accurately determine which areas of the brain are activated when a person experiences fear or euphoria. But you do not need to scan the brain to see how the market plays with these emotions: the Dow Jones Industrial Average index fell by about 5,000 points from the beginning of October to the end of December last year, and was able to recover only by 3,000 points by January 30, and this is one of the biggest failures in recent history.
Similar situations can be unpleasant. Do I need to buy, sell, or is it better not to do anything? Should I ignore the noise that rises around deals? This is good if you are a disciplined long-term investor, but it will help little if you earn on trading or receive a percentage of clients' earnings.
Psychology of Finance
Financial behavior experts offer several answers to the question of how to deal with difficult situations. On the one hand, it is well known that investing is an emotional act. Most people’s market-related emotions and feelings are due to brain biochemistry. However, our instincts are unlikely to help survive in the market.
Although not everything is so bleak. Recognizing how emotions can confuse them, investors can take steps to protect themselves from their worst impulses. Financial advisors can play a decisive role in educating clients to understand their inner self and to avoid making mistakes when investing. Many financial companies train consultants to look more like therapists and trainers. Behavioral coaching is often seen as a key service. The work of consultants is to understand what drives the people with whom they have to work, and not just create portfolios and advise investors.
Unfortunately, this is not an exact science. Brad Barber, a professor of finance at the University of California, Davis, believes that there is not enough scientific evidence to determine the method of intervention or coaching that always works. It's like trying to find a universal cure for cancer. Genetic variations are so great that everyone needs an individual medicine.
Several leading American financial behavior experts have presented several mental tricks that will help you to not give in to your emotions and instincts and not harm yourself.
Do not hold on to bad investments
Many investors cannot part with loss-making stocks. This type of behavior, documented in academic research, can be quite expensive. According to studies, the level of income from such shares is 3.4% lower.
One solution is to ask yourself why you keep clinging to losing stocks. Because you, based on new information, really believe that they will recover ,? You do not want to sell, because it would mean to admit that it was a bad investment?
Consider rethinking the loss as an opportunity, as a “transfer of assets” to stocks or funds that make sense in the current environment. Avoid the phrase “sell your bad stocks” because it makes you feel like a failure. Winners transfer their assets.
You sell winning stocks too soon
If you have any income from securities, the temptation to sell and take profits can be very strong. Many studies show that investors are more likely to sell assets that have grown than those that have declined.This is a trend known as the “alienation effect”.
One way to avoid prejudice is to hide the purchase price of the stock on your trading screen. The more significant the purchase information is, the higher the likelihood that you will trade, and manipulating the significance of the information can improve trading performance.
You need to strive to correctly evaluate the information you have: do you think that the stock or fund still has good long-term prospects, or maybe you are aware of some kind of information advantage that everyone else is missing. Do not get hung up on what is not related to performance, for example, on the price you paid.
You are too confident and risking
Many investors overestimate their skills and underestimate external risks. They believe that they can outwit the market by choosing individual stocks (most studies show that this is unlikely). They may also be overly optimistic about the prospects for stock returns, which subsequently affects pension investments.
If you choose stocks or work with funds, do it with an amount that does not have a significant impact on your retirement. And avoid the temptation to trade often.
If you tend to underestimate risks, look in the media for stories or analyzes with the opposite point of view. If overconfidence forces you to take careless risks, then a slightly increased emphasis on negativity can make you more cautious.
You focus on the wrong signals
Many people do not have a system in their investments and are constantly looking for an explanation of the chaos around them. They look for models that represent the past, and confirm their previous theories. Mostly we come across false ideas that encourage us to trade based on distorted data or high-profile headlines.
If you are in a difficult situation, carefully study your investment and find out what you are doing right and wrong. Investors are usually inclined to what attracts their attention. You need to study what you did and did not do, keep records and see what works and what doesn't.
Stocks are falling and you want to sell them
Most people are biased about what is relevant at the moment, expecting that the latest trends will continue. And it’s hard to put up with short-term problems, even if you know about the remuneration that can be received only after many years (for example, more money in a retirement account).
Instead of making a mistake and selling paper when everything looks gloomy, think of a reward for yourself. There is a psychological trick that can help: instead of focusing on the pain when visiting the gym, replace the expectation of discomfort with a reward for a good workout, such as a massage or a date with your spouse.
And attach a note to your computer with Warren Buffett's advice: be greedy when others are afraid.