Investing Psychology Is Against You

There are so many ways that your own psychology is against you like loss aversion, sunk cost fallacy, anchoring, and much more. You are your own worst enemy and by understanding this you can invest smarter.

This is where a lot of this is explained and it is an amazing piece of material every investor should read: https://www.investopedia.com/terms/b/behavioralfinance.asp

It’s important before we start to level set what we are talking about. Fundamental analysis of assets is where you look at the financials of a company within the context of its industry and has little to do with psychology.

When we are talking about technical analysis which focuses on trends, patterns, and other indicators, market psychology is a large component of this, and this is what we are discussing today. Most investors are not investing based on the numbers and instead focus on more superficial factors, namely their own emotions.

There is so much going against you so if you think the odds are in your favor, refer to this to ground you and help you invest more rationally.

According to Investopedia, the 2 best approaches to avoiding emotional investing are diversification and dollar-cost averaging. This is exactly what I’ve always done and recommended to lower risk exposure and because dollar-cost averaging has been proven to return the best profits over time.

Also, if you’re interested in fallacies and the ways our emotions and thinking can mess us up, I highly recommend learning about all logical fallacies and biases. I used to do a weekly post summarizing 5 fallacies and did something like 20 posts in the past. I think it’s really beneficial to understand and internalize these.

In a perfect world, the rational and logical investor would believe in the efficient market hypothesis (EMH). This means that all stock prices are valued accurately based on the information available. Unfortunately, biases, behaviors, and more get in the way and we end up with the irrational market we have today. If anything, the EMH is a guide for what assets should strive to be and while the market can be irrational, you can minimize risk in many ways.

I think the most effective and simplest way to beat out all the emotional fallacies, biases, and behaviors that negatively affect your finances is to always ask the question “What makes me special?” For example, you want to start day trading and look at the statistics that most people fail, so ask yourself, “What makes me special?” You should almost always come to the conclusion that you’re not special and that you are just as likely to fail as anyone else. This isn’t to discourage you, it’s to keep you rational and level-headed with your finances so you don’t lose money.

How big of a part does our psychology play in investing? Is investing more about algorithms or human emotion? Is behavioral finance the key to success? Let me know what you think about this in the comments below and don’t forget to subscribe!