Here’s a scenario you may have heard about in recent times: FOMOing into a trade only to realise later that you’ve bought in at the very top and now you’re stuck holding the bag. Sounds familiar?
If you have dabbled in trading stocks or cryptocurrencies before, I am almost certain that you've either felt greedy or fearful at some point. This is a story about discovering just how emotional a person can become when it comes to trading and then learning how to overcome it.
Remember the meme stock craze that started in 2021? Like so many others who were lured by the media hype, I was eager to join the gold rush with hopes of making some extra cash. Armed with zero-commission trading apps and easy market access, retail traders like myself flooded the market and became a force to reckon with. Additionally, being stuck at home at the height of the COVID-19 pandemic also meant plenty of time spent indoors cooking up ways to make quick and easy money.
Or so I thought. Trading was far from easy, and the biggest challenge I encountered was in myself, or rather my own emotions. I won’t go into the details of my trade positions nor reveal what investments I made as this isn’t financial advice, but needless to say, my emotions got the better of me.
If you don’t already know, emotional trading is when you allow emotions to impact your investment decisions. For example, panic selling at the first sign of a dip in the market or panic buying based on media hype. Other signs of emotional trading include getting into trading positions without a stop loss in place and obsessively checking prices every few seconds.
I ticked all of the boxes during my first few attempts at trading. Being the inexperienced trader that I was, I thought I’d just go in and out and make a quick buck like all those professional day traders I’ve heard about. Instead, all sense of rationality was quickly taken over by greed followed soon after by panic selling at a loss. In the time between buying and selling, I was anxiously checking my trading app at any given minute of the day and even lost sleep over it.
Fortunately, despite my recklessness, I was wise enough to know that you should never invest money you cannot afford to lose (a lesson for another post, perhaps). Nevertheless, it was a costly lesson that I had to learn the hard way. Shortly after the experience, I decided to try and understand why I behaved so irrationally and see if there was any way I could keep my emotions in check while trading. Here are a few approaches that have subsequently worked for me:
Initially, I had no clue what I was investing in. I had not done my due diligence nor did I understand investing fundamentals. This resulted in me making rash decisions and being easily swayed by hype.
In contrast, an investor who has conducted thorough research and developed a sound investing strategy would not have been so easily influenced. As the saying goes, knowledge is power and will result in having conviction and trust in your investments. This gave me the willpower to drown out any anxiety or greed that I felt.
Knowing what I invested in also means fully understanding all the associated risks that come with it. There are two kinds of risk: systemic and unsystemic. Systemic risks affect entire economies and markets, whereas unsystemic risks are industry or company-specific risks.
I found that having a good understanding of risk helps me mentally prepare myself for bad market scenarios so that I am not shocked or caught off guard if it happens. It also gives me the opportunity to put contingency plans in place before something bad happens. This then translates into a much calmer trading environment for me.
Dollar-cost averaging is a strategy that involves investing a fixed amount of money into the same investment at regular intervals, regardless of the asset price at the time of purchase. As an example, let’s assume the price of a stock that you bought has dropped since the initial buy-in. By applying dollar-cost averaging, you invest a fixed sum of money to purchase more of the same stock but at a lower price. This results in a lowered breakeven price point for your stock. On the other hand, you purchase fewer of the same stock when prices are trending upwards while increasing the size of your portfolio.
This is a great strategy because it allows your investment to accumulate consistently over time and disregards market fluctuations. Once I started applying the strategy, I felt less prone to making any emotion-based investment decisions — especially in times of high market volatility where I tend to feel jittery.
The old proverb of not putting all your eggs in one basket is a time-tested strategy for mitigating risks in investing. Portfolio diversification simply means buying a variety of securities instead of just one type or a handful. Diversification can be classified through different asset classes, industries, or companies, just to name a few.
Having a diversified portfolio of securities has helped me reduce my chances of behaving emotionally, because the losses suffered in some of my investments could be offset by gains in others. There have only been a few times in the past where prices of all major asset classes have moved in the same direction, such as the extreme bear market in 2008, leaving investors with no safe haven. Such events, however, are relatively rare.
If you manage your own portfolio like me, you will know that it is difficult given our emotive nature as human beings. While there are perks to actively managing your own portfolio, the chances of making emotionally rash decisions are higher as well. So, I thought, “why not let another person manage some of my funds for me instead?”
So I started looking into the various portfolio management services available in the market, but a thought occurred to me that if I can’t contain my emotions well, perhaps another human being is no better too. I get how some people would prefer the human connection, but it wasn’t enough to alleviate my scepticism.
And then I found out about robo investment services. In recent years, robo wealth services have steadily grown in popularity due to its sophistication and ability to identify market signals through built-in algorithms. It can also construct portfolios to match individual risk profiles and do periodic portfolio rebalancing to adjust to current market conditions. It was appealing to me because it works on a purely rational-based investment decision-making process that takes human emotions out of the equation. No hard feelings at all!
Trading is tough, no doubt about it. The main takeaway for me is that managing emotions is key so that you don’t get wrecked while trading. In the end, I am only human, and I’ve since understood that these feelings are only natural. So, it’s probably best to work around them using the methods outlined above rather than fight the impossible.
Makes sense to me!
Sources: Investopedia, e27, Forbes