The Stock Market: There Is an Emotional Trap You Shouldn’t Go In

Amidst the crazy ups and downs of the stock market, mood swings going crazy is not a surprise. Reading financial articles about stock investment, you might find similar things — ‘being calm in the chaos is the key’. Yes, it is but how?

First, we are humans so asking us to eliminate emotions from stock investing is an impossible mission. However, the thing we should do (in most cases) is to learn to control our feelings. For example, self-possession instead of panic in the downtrends.

Admitting the fact that investing goes hand in hand with risk no matter how supposedly safe the asset seems. So, be mentally ready for losses rather than expect all-time wins.

There are two important terms related to risk that you should know, risk capacity and risk tolerance. Risk capacity refers to the necessary risk you should take to achieve your financial goals. Meanwhile, risk tolerance indicates how much risk you can handle both financially and emotionally.

For instance, you have been investing in your retirement account since a younger age. You might have the same risk capacity yet lower risk tolerance when time ticks by. As you do not want your retirement fund to keep you up at night.

According to Zach Teutsch, a managing partner at Values Added Financial, there will be differences in volatility acceptance at different times in different people’s lives. Experts also point out that young people are more likely to take riskier trades/bets rather than stable assets.

So, aspects related to risk management can now come along with emotion management and psychology. At the end of the day, what matters in long-term investing? Here are some ways you can use to measure risk in your investments. Please take these ideas as recommendations instead of financial advice!

Identify What You Want to Achieve and Possible Risks

One of the anchors to determining risk tolerance is what you want to achieve from your investment.

When do you want to pay for something? How much does it cost? What do you need to invest to get what you want? These questions can clarify the rewards at the end of the process.

Risk tolerance will make you question the importance and the ambitious level of the goals. In other words, you will wonder whether the risk is worth it or not. As it is obvious that ambitious goals have a close relationship with high risks!

In the process of planning out your investments, it is crucial to determine your risk profile along with your financial goals. Hersh Shelfrin, a professor of finance at Santa Clara University’s Leavey School of Business, suggests writing yourself a letter with different scenarios and your policies as benchmarks for your decisions.

Sit Down With Your Thoughts About Risk Tolerance and Biases

We all have biases that we are or are not aware of. These things can profoundly impact our daily lives and investment decisions. There are cognitive biases, referring to concepts and beliefs that may or may not be true, and emotional biases, at the moment.

For example, a sentimental investor will have a hard time dealing with numbers and analysis. They tend to believe in their guts to make decisions. The more individualized risk you undertake, the more upside and losses you may experience.

So, having time with your thoughts about risk tolerance and biases can help you better deal with tough situations through more logical thinking. Your behavioral patterns of yours can be spotted so that you can foresee your reactions in different trading circumstances. Thus, you can better your income through the management of your emotions.

Admit Risks in Investing and Be Patient to Watch the ‘Show’

An indisputable fact does not mean that we already admitted it. Sometimes, it is easier to overlook it and let our biases lead the way. It is important to admit that investments are risky due to tumultuous price actions. So, you can prepare effective strategies for minimal losses.

When being fully aware of market volatility and its relevant risks, you can patiently observe the rise and fall of price actions. Instead of reacting to temporary trends, you can sit out the downfall and capture the prime time.

For example, if you panicked and sold stocks when the market crashed in 2020 due to the Covid-19 pandemic, you would have missed out on profits as the market rebounded.

Now the situation is downhill again, the lesson here is to patiently watch the present trends. As investing is a long-term effort so we need to have a long-term vision rather than prompt reactions. If you panic selling again, you might miss the recouped profits as the market gets to its rally point.

It does not mean that you have to maintain positions. If things go beyond your risk tolerance, or if you need money on the spot, you should take timely action. Yet, if things are still under control, you should not panic and react based on your instincts.

Data-Driven Analysis Can Tell the Truth

Patience does not mean that you should stay inactive all the time. Yet, there is the risk of inaction, too. So, we need to have benchmarks or standards for our actions or decisions. It is an analysis or evaluation for insights into price actions and forms a base for decisions.

Investing can be hard and also boring as it is a long-term process. So, if you have too much excitement while investing, it is a signal for worriment as investing should not be too exciting.

Thus, you need to keep track of your investments for timely adjustments through effective tools and strategies. Such data-driven analysis can help you take actions based on databases rather than feelings!