Continuation of the series of publications “Psychology of investments”: 5 traps of a investor:
Continuation of the series of publications “Psychology of investments”: 5 traps of a investor:
1. Comparison with others
People tend to constantly judge themselves by the success of others. This is one of the innate habits associated with competition for limited resources. In investments, this manifests itself as follows: when someone sees hundreds of percent of profit, a person either seeks to beat this result, or he drops his hands, because he understands that he will lose in this race.
This psychological trap gives rise to maximalism in the spirit: “To love is like a queen, to steal is like a million.” It has nothing to do with the real market. The average result of investors in the US over the past two years is 9.5% per annum in domestic securities and 4.3% in foreign ones. Both are worse than indexes.
How to avoid it
The main method of struggle is the same as in other situations where comparison harms a person (that is, almost everywhere except sports). You need to set yourself a specific goal, for example, saving for a house or retirement. And remember it every time you are pushed to compare with other people: I have my strategy, and it is only mine.
2. The confirmation trap
People tend to seek approval of their actions from other people. We are a socially oriented species, and this is at the core of our genes. But in investments it can interfere. For example, when we have made a decision that worries us, and unconsciously we are looking for confirmation of our correctness in the posts of other investors or articles by analysts.
The negative is that the decision may be objectively disadvantageous for you and contradict your main goal. For example, you bought bad paper and are hesitant to sell it because many people are sitting in it, including experts who say that the company is undervalued. Or vice versa: do not buy good paper for a long time, because it is considered expensive.
How to avoid it
You should consciously, stepping over yourself, look for and find opinions that speak against your decision. And if they are more reasonable and balanced than those who supported you, then you should change your mind. The opposite can also happen: all opposing arguments will be weak and unconvincing. Then the truth is on your side, and nothing needs to be changed.
3. Overconfidence
Successful transactions give rise to the feeling that you have finally comprehended the Truth, and you can earn more than others — therefore, it is not necessary to listen to outsiders’ opinions, especially if these people, unlike you, lose money or earn less. For an investor, this is one of the surest signs of his imminent fall.
In fact, your success, like the failures of others, can be more than 90% due to chance. For you it was good luck, for others it was bad luck. The market can soon easily switch places for you. There are many brilliant mathematicians and Nobel Prize-winning economists in the world. They are definitely smarter than you. And all of them at least once lost money in the market.
How to avoid it
It is worth recording and analyzing your erroneous trades. Everyone has them, but in your case (since you are successful now), they have not yet made much of a difference. In the future, small mistakes can lead to big losses. Therefore, when counting the profit from successful transactions, do not forget to write down small-profit and unprofitable transactions side by side.
4. Loss avoidance
Any normal person wants a positive return on the invested effort, time and resources. If he has invested in a company, then it becomes valuable to him simply by the fact of the money spent on it. And the fall of the shares of this company does not change this perception much: since the funds were invested, then it is impossible to sell at a loss.
This is again a useful property in everyday life or relationships with the opposite sex. Loss avoidance binds people to each other, keeps families together, allows you to overcome crises in your personal business. But for a minority shareholder who owns insignificant shares of the company, such excessive reflection on his shares is not always appropriate.
How to avoid it
There is a technique that allows you to evaluate how valuable this or that investment is for you. If you are ready now to buy it again, then it’s all right, keep it on. If not, you should close the position. It is not necessary to buy more on a drawdown, you may already have a sufficient share of this company. But it is important to give yourself an honest answer to the question: “Would you invest in it right now at the current price for the same amount?”
5. Limited visibility
People constantly filter information so as not to overload the brain with unnecessary facts. This natural setting often works against the investor when he has neither the time nor the inclination to learn some tools outside of those he is already used to. Bonds, funds, novelties of recent IPOs, foreign stocks are automatically eliminated. The eyes literally “do not see” the news about them.
The main negative of such a setting is that the investor exposes himself to increased risk without receiving a commensurate reward for this. 5–10–20 familiar stocks account for less than 1% of the stock market universe, and betting on them reduces diversification to the extreme, raising the loss scenario: due to changes in currencies, commodity prices, legislation, or whatever.
How to avoid it
It is worth asking yourself a provocative question: am I ready to invest all my money in, for example, the top 10 Brazilian stocks (instead of the US)? Or in Turkish lira (instead of dollar)? Or into woodworking (instead of oil and steel)? If not, then you should start adding something new to your portfolio. Better gradually. For example, buy a few ETFs on all foreign markets for balance and, as it grows, buy additional individual countries and their companies with interesting dynamics and prospects.
