The share market is often said to have a personality all of its own – with good reason.
It is not made up of machines making logical pre-programmed decisions. It comprises investors – individual and collective – who often react emotionally and sometimes irrationally to good and bad news. Known as behavioural investing, it is especially important to be aware of during periods of market turbulence.
Hunting in Packs
Many investors tend to hunt in packs, making investment decisions based on what the rest of the herd is doing. The media tends to perpetuate this style of investing – printing sensational headlines that often exaggerate the reality of current market conditions.
On a bad day, shares can be ‘savaged’ or ‘mauled’ by an unforgiving share market, while on a good day, they can be ‘rewarded’ or ‘boosted’.
Such headlines often lead to bandwagon jumping, where investors panic and react by buying or selling particular shares. Panic replaces rational consideration, masking the true underlying value of the shares, or the strength of the company behind them.
It is important to remember that the way we comprehend and act on information may cause us to buy shares that are over-valued, or sell fundamentally sound under-valued shares which have reached the bottom of the cycle and have a favourable earnings outlook.
Are you prone to any of these emotional or psychological impulses?
- Overconfidence – trading too much or taking too much risk in one area
- Loss aversion or fear of regret – not taking action when necessary to buy or sell shares
- Mental accounting – holding an emotional attachment to individual investments
- Anchoring – placing too much credence in recent price movements and not enough in the long-term history of a share
- Procrastination – not acting in your best interests due to inertia, you can end up constantly worry about selling ‘winners’ too soon and getting rid of ‘losers’ too late
- Pack mentality – over-reacting to every piece of bad and good news; becoming too optimistic when the market rises and too pessimistic when the market falls.
A disciplined approach to investing is the key to avoiding the potential pitfalls of an emotional response. By using rational thought rather than emotion, and by ensuring your portfolio is diversified over the long term, you are more likely to see your financial goals achieved.
If you have any queries about your investment strategy or how to minimise the likelihood of emotionally influenced decision-making in today’s environment, talk to us today.