Emotional finance management is difficult at the best of times, but it can be nearly impossible to regulate while under stress, especially when money is involved. This may be most notably observed when you look at people invested in the stock market. It can be incredibly hard to keep emotions in check when thousands of dollars of your hard-earned money are on the line. However, the most successful investors are those that can set their emotions aside and think about things as logically as possible.
Behavioral Finance
The question as to whether traders are ever rational implies the assumption that most traders are not. And this may be true, at least some of the time. Psychological fallacies such as gambler’s fallacy, market euphoria, the hot hand fallacy, and others are at work to try to undermine your hard work in understanding global markets. The good news is that all of the potential issues mentioned have solutions that are mostly the same.
Some of these solutions include remaining calm, taking things one day, or one investment, at a time, and being careful not to get too caught up in the emotional rollercoaster that people tend to hop on when they are riding significant successes or failures.
Rational traders can overcome their false assumptions, often knowing the signs that they are falling into one of the aforementioned patterns of behavior. Having that self-awareness, along with knowing the signs of each, can be invaluable. It is not that successful traders do not experience things like the hot hand fallacy, they have just learned the skills needed to act rationally while experiencing the same mental symptoms as other people in the same situations.
Successful traders can recognize their emotional attachment to their stock market portfolio but avoid making decisions based on those emotions. Instead, they can look at numbers, read patterns, and all the other factors that tell them whether it is time to buy or sell and use those observations to inform the decision to invest, sell, or hold on to any given asset.
Rather than letting emotions get in the way of a smart investment decision, these investors can recognize and deal with any emotions connected to their investments.
While it sounds simple, separating yourself from your investments is an incredibly difficult task. Most people who invest in the stock market have large sums of money at stake, and stress, along with the other fallacies already mentioned, can play a huge role in making good financial decisions.
Most notably, loss aversion can cause people to try to simply avoid losing money rather than taking the calculated risks necessary to earn money on the stock market. This fallacy can be especially detrimental to financial success, along with one of the harder ones to recognize. Avoiding losses is obviously something to strive for, but people caught in the cycle of loss aversion often do so while refusing to take necessary risks. Again, successful traders can overcome this psychological fallacy.