When we invest and we make a loss, we blame the markets, the magazine which gave the hot tip, the financial expert on business television. We never stop and think that the cause is ourselves. There is a lot of financial research which show that the worst enemy in investing is ourselves. Let me share:
We do not cut the level of risk in investing. Even if we have methods to cut the risk, we do not use them properly and negate the benefit of the risk reduction methods. For example, we know that buying bonds is a risk reduction method. But we can negate the benefits of this method by putting all our money into the bonds of one company or buying risky individual stocks with 60% of our money and investing 40% in bonds. Doing such things actually increase your risk.
We ascribe human qualities to a stock. We start trusting a stock if it goes up after we buy it. We start distrusting a stock if it goes down after we have bought it. This is nonsense. A stock is a piece of business who price changes with the mood of the market and whose value depends on its earning ability and profitability and the price at which you can buy it,
We rely on gut feelings to make buy and sell decisions while successful investing demands analysis and careful thinking. Using gut feelings to make an investment is wrong.
We respond to changes in the market which are actually noise and not real changes. A 200 point raise in the Sensex from 20,000 is only a 1% raise. But it feels like a lot more and we start making decisions based on such changes where as it is probably only market noise.
You buy a stock because you like the company’s product, you see it in a lot of shops, there is positive news about the stock and it is going up in price. However before you buy a stock you should ask yourself about the industry, the competition, the management and its strategy and the anticipated demand for the product.
We rush to buy a hot stock because we are lazy to analyse and we are greedy and ignorant. We don’t pay nearly as much attention to what’s going on around ourselves as we think we do.This explains why a lot of internet dot-com companies rose in price during the late 1990’s.
Our brains are so much addicted to emotional highs of profit-making that we care more about how much money we might conceivably make(buying a lottery ticket when the jackpot is huge) than we care about the probability of making anything at all.
We believe in what the so-called experts say. But in the financial world, experts don’t have any insight into the future and cannot predict accurately. What we need to do is be greedy when others are fearful and be fearful when others are greedy and we do not do that.
We think we can predict short-term price movements. But these movements are largely random. We find patterns where none exist and as a result over long periods of time we lose and not gain.
We are overconfident. We think that we are better than we really are. We think we can predict the market. Therefore we over trade. Therefore we underperform the market.
We don’t know how to deal with risk. We do not know how to cut losses and ride profits. We do not know how to be greedy when others are fearful and fearful when others are greedy. We do not rebalance our portfolios.
We do not accept we don’t know. That’s why we make a lot of foolish decisions. If you can accept you don’t know you will follow a good plan over the years and you will be successful in investing and in life.