Understanding the Role of Psychological Factors in Investing

Although a lot of different factors go into making someone a successful investor, a large part of their success usually can be attributed to psychology. Familiarizing yourself with your own thought patterns, beliefs, and preconceptions can give you deeper insight into how and why you make certain decisions. It can also help you get control over unproductive emotions like greed or fear. Understanding how these emotions affect your actions will ultimately make you a better investor.

 New investors typically have a lot of misconceptions. They may mistakenly believe that the key to success is discovering a winning strategy and sticking with it. While that is true to some extent, it is not always quite as easy as it sounds. For instance, imagine that you have invested wisely using a strategy that you believe will help you succeed, building up a well-planned portfolio over time. What happens if the market takes a turn for the worse and your investments start plummeting? What emotions will you experience? What actions will you take? For most people, the thought of losing money is so disconcerting that they wind up holding on to their investments longer than they should in the hopes that they will go back up again.

 A 1991 study done by Tversky and Kahneman found that the number of pain people experienced if they lost one dollar was nearly twice as much as the pleasure they felt if they gained one dollar. When you understand this, it is easy to see why investors often wind up holding their stock even when it is declining in value rather than selling it to hold onto as much capital as they can. This is one example of how emotions can interfere with your ability to make smart decisions. It is one thing to tell yourself that you should sell early to minimize your losses. It is another thing altogether to follow through on that action. Overcoming the emotional pull to hold on to your investments in the hope that they will recover can be challenging.

 In an ideal world, all investing would be guided by rational thought rather than by emotions. Unfortunately, that isn’t the way that it works for most people. You can improve your chances of overcoming your emotions, however, by familiarizing yourself with your thought patterns and your weaknesses. Understanding your own personal tendencies and beliefs will make you a better investor overall.

 Action Steps:

 * Familiarize yourself with some of the most frequent mistakes made by investors. Read up on how to avoid them.

 * Go through some of the material in the list of suggested reading below.

 * Use the tools and tests listed below to evaluate your own personal psychology so that you can better understand yourself and your tendencies as an investor.

 Mistakes Investors Commonly Make and Tips On How to Avoid Them

 Becoming Too Attached To Your Investments from an Emotional Standpoint

 If you allow yourself to become overly attached to one of your investments, it could interfere with your decision-making ability. When your emotions are involved, it is easy to veer off of your investment strategy. You may also be more likely to overlook negative information about the investment. It is too easy to fall into the trap of letting your emotions guide you rather than carefully thinking through your decisions. Rather than becoming emotionally attached to a particular investment, focus on your overall investment strategy. That way, you can make decisions with a clear head without your emotions getting in the way. In time you will learn how to invest 1 million pounds.

 Failing To Define What You Consider Acceptable Losses

 Every investor loses money at one point or another, no matter how long they have been in the game. As soon as you make an investment, you should decide what you consider to be an acceptable loss for that investment. The figure that you come up with should be something that you can comfortably lose. Don’t feel like you have to stick to any specific rules. Instead, it is about deciding how much you can lose without going outside of your comfort zone. It is important to remember, however, that you have to keep your losses to a minimum if you want to be successful. Along with taking steps to reduce your risk, you also have to stick to your plan when it comes to losses. Don’t get so caught up in the process that you allow small losses to grow too large. Instead, follow your plan and sell when your losses exceed the acceptable level that you decided on.

 Constantly Looking For the Perfect Strategy

 A lot of times, when investors are just getting started, they will begin by learning a specific investing technique. When they apply that technique, they may have a few investments that go well. As soon as they start experiencing losses, however, they move on to a different strategy, always searching for the perfect trading technique. This process, which is known as the Beginner’s Cycle, can be extremely detrimental. If you find yourself falling into this trap, take a step back and focus on a single investment strategy instead. Remember – losses are a normal part of investing. Even the best investment strategy will periodically result in losses.

This list barely scratches the surface when it comes to mistakes that new investors make. As you step further into the world of investing, make sure to educate yourself as much as possible. The resources listed below are a great starting point.