Keeping Your Emotions in Check

Keeping Your Emotions in Check The biggest obstacle in making good investment decisions is probably our emotions. Numerous studies over the years have found that investors have certain psychological biases that get in the way of making purely rational decisions.

We look for patterns in life, even when they don't exist.
Thus when the market is going up, we think it will continue on that track indefinitely and continue to invest as the market gets higher and higher When the market is going down, we fear it will continue to do so forever and avoid investing, even when process are attractive. This causes investors to buy high and sell low, the opposite of what they should be doing.

We would rather avoid losses than obtain gains.
Thus, we tend to hold on to stocks with losses for an inordinate amount of time, hoping the stock will get back to breakeven so we won't have to admit we lost money. On the other hand, we tend to sell investments with gains too quickly, so we can lock in those gains.

We become more risk tolerant when we have gains on investments.
As those gains disapear, however, investors become more risk averse because their principal is at risk. This can lead to selling when investments are at market lows.

We tend to attribute investment success to our own ability and market losses to matters outside our control.

During the bull market of the 1990's, many investors believed their gains were a result of their keen investment savvy, rather than a result of the overall rise in the market. But as the market started to decline those same investors often blamed factors outside their control, which led to inaction.

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