Much has been written on the part of psychology in stock market success. We've all witnessed recently just how crazy the markets can get.
These lessons in psychology are probably the easiest to learn and hardest to implement since they actually go against how we are "programmed", as humans. There are reasons for our behavior, probably good ones but in the stock markets we need to adopt a whole other state of mind to succeed.
Psychology is everywhere in the stock market and effects all from the novice to the most professional (aside for computers). The two common most repeated advice in investing: making long term investments and diversifying the portfolio are good advice which have also stemmed from the need to guard against mistakes caused by our psychological biases.
Many investors make the same mistakes over and over again. Mistakes such as: selling profitable stocks too soon, holding on to losing stocks forever or lacking the discipline to stay in the market and avoid frequent buying and selling are all a result of poor understanding of key psychological factors required to succeed in the stock market.
Knowing the enemy is the first part in defeating it. So, with our further introductions, here are the common psychological factors at play in the stock market:
Anchoring
Anchoring is a psychological phenomenon in which one judges data (a stock price or exchange rate) by comparing it to a certain anchored similar data. Is 1 euro for 1.4 $ expansive? Since it has been cheaper we tend to think it is more expansive now, but is it? Just because market prices are high it does not mean they can't get any higher.
Biased risk avoidance
Kahneman and Tversky have shown people tend to avoid risk in potential profits and prefer risks in potential losses (preferring a raffle to a certain loss for example). One must always consider the investment at hand from a statistical point of view regardless of irrationality forced by our minds at times.
Over confidence
A common psychological factor in investment is over confidence. We're always sure we're going to beat the market. Our investments are always good ones. We often accredit more to known factors about a stock then to the unknown and take little of the unknown into consideration.
Lack of self discipline
Be disciplined in your investment or trading techniques. Be consistent in your decisions and do not be afraid to back them up. Do not allow yourself to be intimidated and weakened by every event in the market. If you in there for the long term: stay there. If you have a stoploss use it.
Lack of self confidence
Trust your experience and instincts (if they've proved to be right so far). Do not be afraid to follow what seems to be a promising investment and do not rush to sell when you've gained some return on investment. Believe in your analysis and in your decisions.
Lack of patience
Successful investing requires patience. Do not have a peek at your portfolio's performance every other minute. Investing for the long term requires years to generate those fabulous high returns we always hear about.
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