Ask any savvy trader or investor, and they’ll tell you about the importance of separating emotions from logic in financial markets. As human beings, we all have behavioral impulses that sometimes get the better of us.
Unfortunately, letting these behavioral impulses overcome rationality and logic can lead to disastrous effects in financial markets. It’s not uncommon for traders and investors to let their emotions reign supreme after closing successful trading positions in a row or losing their investment capital in a trade gone awry.
Sometimes, traders and investors become overjubilant after making a few successful trades or investments. As a result, they become overly confident and complacent in their future investment positions. Likewise, it’s also not uncommon for traders and investors to become overly emotional following a few poor trades or investments. They become obsessed with recouping their investment and, as a result, start making poor trading or investing decisions that compound their losses further.
Thus, avoiding these emotions from creeping into your investing or trading strategy is crucial. It’s easy to get carried away when you hear news about a company’s stock going belly up or get positive information about a stock you’ve been considering. However, refrain from succumbing to your emotional urges. Instead, consider moving forward with a clear head to make the best trading or investing decisions possible.
Ways to Refrain from Emotional Investing
Preventing emotions from creeping into your trading or investing strategy is challenging. However, it’s not impossible. Here’s how you can refrain from emotional investing:
Establish Long-Term Goals
Whether you’re a trader or an investor, you’ll have long-term goals that you want to accomplish by participating in financial markets. For instance, traders try capitalizing on price fluctuations to outperform the market. However, what’s the reason behind their trading? Some might want to make trading their full-time job, while others want to generate significant returns to save for retirement.
Establishing your long-term goals is crucial because it allows you to create an investing or trading plan that you can follow.
Create a Trading or Investing Plan
Once you’ve established your long-term goals, consider creating a trading or investing plan. This plan should outline your risk tolerance and risk management principles. In addition, it should also include information about entry and exit policies for trades.
Creating a trading plan is beneficial because it prevents you from reacting emotionally to market changes.
Use the News for Information Rather Than Decisions
Traders and investors often react to news events, using them to make trading or investing decisions. While news events can help make informed decisions, refrain from using the news as the basis for your decision-making. Instead, use the news to get more information about a company’s fundamentals or the current market scenario.
For instance, many traders often see a company report positive financial numbers in their quarterly reports. They consider this a sign to invest in the company without performing technical analysis. Doing so puts you at risk, and data backs up this assertion. Research shows the S&P 500 outperformed the average US investor by nearly 70 percent between 1997 to 2016.
The research showed that the average investor generated approximately 2.3 percent annual returns, while the S&P 500 yielded 7.7 percent annualized returns in the same period. Numerous factors contribute to the average US investor underperforming compared to the S&P 500. However, the primary reason is that most investors make poor decisions because they let the news cycle infiltrate their psyche.
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