How to understand and control emotions when investing

By Danielle Ecuyer

May 22 2020
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When it comes to investing, our emotions are both a blessing and a curse. Emotions in share investing are often referred to as animal spirits and that about sums it up. No matter how much we rationalise and make plans, when it comes to our own money, no one likes to see a paper loss (shares have dropped since purchase) and all of us love to see a paper profit (shares have risen since purchase).

understand and control emotions when investing

Some of you will be better at managing your emotions than others, but even the best find sharemarket sell-offs unpleasant. The same can be said for that little knot in the stomach that arrives when share prices rally really quickly. There is always a niggling doubt, when will this end?

So, let’s run through some of the emotions that you need to consider and try to manage.

1. Animal spirits – There has been an acute case of animal spirits post the March 2020 coronavirus crash. Following a 37 per cent fall from the late February bull market peak, the ASX 200 rallied 22 per cent. The gains have been higher in the US Nasdaq (the technology index) up almost 34 per cent at the recent high. There are no shortage naysayers querying these rallies, reflecting the disconnect between the economic fallout from the lockdowns versus what some see as the irrational exuberance of the sharemarkets. The answer lies in part to animal spirits – markets go up sometimes because they just want to go up on hope and optimism (sentiment). And the more they rise, the more you feel the drag of buy, buy, buy or not missing out.

2. FOMO (greed) and FONGO (fear) – These anacronyms mean “fear of missing out” (FOMO) and “fear of not getting out” (FONGO). The previous example of animal spirits can easily create a strong FOMO sensation. The “buy now, pay later” share AfterPay is a great example. Shares crashed to a low around $9 in March and have since rallied over five times to $45. My hunch is there were many investors who panicked with fear (FONGO) and dumped the shares in March, only to throw their hands up in frustration and buy back in at a higher level once the AfterPay shares started to rally-FOMO or greed.

The trick with both of these powerful emotions is to try and rationalise what your investment actions are – am I buying it for a trade? Should I be selling because the share is really in trouble or is it just a liquidity sell-off? The answers to these questions will largely depend on your circumstances – how much you have to invest, are you trying to preserve capital or whether you are a risk taker. And most importantly, do you know the share well enough to make a rational call on whether it is truly a buy or a sell. There is no one answer, except you want to try and avoid buyer’s or seller’s regret when our emotions become swept up in the herd-like behaviour of the market. Investing is always a risk-reward exercise, so if you aren’t sure or you can’t afford to lose some capital, even temporarily, then it might be best to stand back from the crowd.

3. Unconscious bias – All of us have the predisposition to seek out information or actions that validate our own. This occurs whether it’s news or a share price movement. When our shares rise, we feel validated that it what the right decision to buy them. When they fall, it is easy to question our judgement if there is no apparent news for the price decrease. The reality is that share prices go up and down and most of the time, we do not know why. Sharemarkets are made up of so many investors pumping millions of dollars through daily, and every one of those investors has a different reason to buy and sell. Yours will be different as well, which means it can be both helpful and misleading to take your queue from the market.

While some investors purely follow momentum and the trends, i.e. where the share prices go, I believe having a personal plan that works for you, with your risk tolerance (how much you can stomach short-term losses for long-term profits) should determine how you invest.

Understanding why you buy a share, and what you are buying (know your shares) will go a long way to helping you stop the irrational emotional responses from overriding your rational mind.

As I read recently: “Investing is 95 per cent temperament. It’s a test of how well you can sit quietly when your emotions are screaming at you to do the wrong thing.”

Danielle Ecuyer is an author and investor with more than three decades of experience in the sharemarket.

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