The easiest way to derail a good stock investment strategy is to bring emotion into the game. Stock securities are little pieces of a company. While human beings are very emotional creatures, the little slips of paper that represent the countless stock trades occurring every single day have no emotion. Furthermore, large institutional investors, who have the largest influence on a stock price because of the size of their trades, operate by a series of trading rules that once again have no emotion as part of the equation.
For you and I, trading stock is partially a psychological game. It’s a battle between our ability to make rational decisions and our tendency to get caught up in emotions of fear, greed, and a desire to be right. Without some fancy neurological operation or disfiguring industrial accident, emotion is a part of the way all of our brains operate. Therefore, it doesn’t do any good to pretend that we don’t have emotion.
Instead, learning how to recognize emotional response is the key to controlling it. This is especially important when money and tight deadlines stare you in the face. To practice recognizing emotions, keep a small journal and as you look at each stock price in your portfolio note any emotions that you feel when you first see the price. Be honest with yourself because this is important. If you a saw price drop below your buy price do you feel a pang of dread in the pit of your stomach? Do you feel yourself justifying why you bought the stock in the first place? Is this followed by thoughts of why you should hold on to the stock to prove to yourself or someone else that you were right?
Rational thinking follows emotional responses. However, rational thinking is also colored by emotional responses. This is why it’s important to recognize when you have these emotional responses, whether good or bad, so you can put yourself back on track and objectively evaluate whether or not you should stick with the stock or get rid of it.
Emotions can also play with your head when the stock is doing well. In my early days of trading I had a stock skyrocket and I was elated. I would look at that one stock and think about how it proved that I knew what I was doing. Rationally the math told me that I had already made plenty of money and it would be a great thing to sell the stock immediately and take the cash.
That’s not what I did.
Instead I rode the stock through the end of the day and into the next morning. Before the markets opened that next day, a press release had come out about this company and while the news wasn’t horrible, it wasn’t positive either. By the time I was able to trade stock that day, major institutional investors followed their standard policy and dumped the stock, driving the price down. My emotions took hold on this loss as well. To make a long story short, what would’ve been a great financial gain became a substantial loss. Institutional investors are sometimes timid about buying back into a stock and once they have started the trend that drives the price down many private investors smartly follow as well.
Looking back on this particular stock I would’ve had to hold on to it for another year just to break even.
This was a tough lesson to learn, indeed. And that’s why emotion should never be a part of your stock investment strategy.
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