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Understanding Your Own Emotions

By Pauline Yong, author of “I Love Stocks”

Studies by economists and psychologists have found that

investors are most

influenced by recent events – market news,

political events, earnings reports

–

and

ignore long term

investment and economic fundamentals.

Furthermore,

with

traders using computers to buy and sell stocks and

receive

information,

news

affecting investor psychology travel faster

than

ever before. As a

result, if a

movement starts in one

direction, it tends to

pick up more and

more investors

with

time and momentum. It’s like a

domino effect!

Successful investors usually do a lot of research and they have

an investment

plan

before they invest. Although a good

research does not guarantee the

performance

of any particular

investment, but it does help to avoid more of

the

bad ones.

Successful investors even develop contingency plans for what

to do

when a special

investment or situation comes along that

requires a little

quicker

action. The goal is

to not let your

emotions or too much information

rule your

investment plan.

The study of market psychology can help investors to identify

the common

mental

mistakes that repeatedly made by them.

Common mistakes

sometimes

lead people

to incorrectly

process new information about a

company and in

turn,

misjudge a

stock’s true value. In general, the stock

market

preys on fear

and

greed, and it’s not

designed to reward the

masses.

In other words, the

stock

market acts on fear,

speculation – and herd

mentality.

Now, let’s go through some of the emotions and mental errors

that cause

stock

prices to move wildly.

Herd Mentality

Herd mentality refers to an irrational collective buying and

selling for no

strong

reason. It could be a surprise rally which

is uncalled for or a panic sell-

off that

defies

the logic. For

example, if a company is expected to pay a big

dividend, its

stock price

will rise - but if that company then pays a less-than-

expected (but

substantial)

dividend, the price will fall. The

company is still

profitable, but it's not

living up to

expectations, hence it faces the selling

pressure. Once the

selling

pressure is initiated

by a group of investors, other

players in the market will

follow suit.

The rationale behind this is: we tend to feel comfortable doing

things

together.

One

can even see this trait in other animals

such as a flock of birds

or a school of

fish.

They seem to follow

a leader.

The way to profit from this phenomenon is to resist the herd

mentality and

try to

a leader. In any crowd, or group

behaviour situation, the ones that

lead are

the ones

that draw

all the benefits, while the ones that follow

blindly

are the ones

that take all

the risks.

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