5 Toxic Investing Habits You Need To Break
Have you ever wondered why some investors consistently profit from the financial markets while the majority barely break even or even lose money over time? It almost seems that these winning investors have some secret formula or magical ability to extract money from the markets year after year.
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I’ll admit, this question has bothered me. I knew there must be a simple reason why some investors are consistently lucky, and others are not. I knew it had little to do with intelligence or even education. I have known many highly educated and intelligent investors who have a tough time earning consistent money from the markets. At the same time, I know several “regular Joe” types with no more than a high school diploma who earn substantial income by investing in the stock market.
After much research and thought, I have determined that the difference between winning investors and everyone else boils down to a single factor: an understanding of human nature.
#-ad_banner-#There are no magic or secret formulas involved. Humans do the same things over and over again, and those investors who know how to exploit these recurring habits are the consistent winners.
1. Overreaction To Events
The market as a whole frequently overreacts to economic and political events. The overreaction sends the stock market on wild gyrations far outside of the normal trading range. Everyone jumps on the bandwagon by either buying or selling, resulting in the market quickly moving to an extreme price level.
Smart investors understand this human trait and wait until the price jump or drop fades away in the inevitable move back to normalcy. Never jump on board with the crowd when the market is soaring in a direction from a single market shock. Always wait for the move to end and start to reverse before entering a trade.
2. Being Emotional About Money
The single factor that differentiates winners from losers in the investment game is emotional control. Many investors become emotional about gains and particularly losses in the stock market. These moods can lead to irrational decision making and deviation from logical investment plans. Once feelings start to control your decisions, losing is almost guaranteed.
Winning investors learn to control their emotions and act in a purely rational way when investing. This means taking profits and losses per your plan without second-guessing yourself. I realize this is extremely difficult, but everyone can do with practice and a well-established investing system.
3. Hindsight Bias
Hindsight bias is a significant problem for many investors. Hindsight bias is a psychological term explaining the tendency to overestimate your ability to have predicted an outcome that could not possibly have been predicted.
Technical analysts and others who use charts to make investing decisions are particularly prone to this. While charts can help traders make solid investment decisions when combined with other analysis, a similar chart pattern to a previous price move does not always guarantee a similar price move ahead.
4. Lacking Patience
Warren Buffett famously said that the stock market is a device for transferring wealth from the impatient investor to the patient investor. Nothing could be more accurate. Realizing that calmly observing your gains over the long term is often the best tactic will allow you to profit from those investors who are less patient.
The stock market is not a get rich quick game. It takes time and patience to build wealth.
5. Buying Only New High Prices
Purchasing new high prices can actually work, depending on market conditions. Trend following and momentum investing are successful techniques that advocate buying new highs. But while only purchasing new highs is a feel-good way to invest, it can often be a mistake.
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Human nature makes buying strength much easier emotionally than buying weakness, but this often the opposite of what you should be doing. It’s better to buy discounted stocks than to continually overpay for momentum-based purchases.
Remember: The best stock market entries are often very uncomfortable.
Risks To Consider: There are many nuances far outside the scope of this article when it comes to an understanding how human nature affects the stock market. An entire field of study known as behavioral finance has developed around how human nature relates to investing. Use the above factors as a starting point to fully understand this fascinating and profitable subject!
Action To Take: Start to think about your emotional biases when investing. Understanding your biases will make it easier to understand why other investors do what they do and enable you to profit from human nature.