However, a significant difference also lies in how they manage their emotions during unexpected events. You don’t want to be completely emotionless, but you need to understand and manage your emotions effectively when making investment decisions.
Emotions can play a part in everyday investing in four ways:
Overall Market Sentiment
Investors determine what phase the market is in by considering big-picture issues like the economy, government policies, and inflation. This collective sentiment can create market instability, affecting share prices regardless of a company’s fundamentals.
Consider the stock market as a battlefield with various players: foreign investors, professional investors and regular investors each employing different strategies. These players are all human, and if humans are involved, emotions will be too.
Industry Outlook
Industry outlook reflects how investors evaluate the potential and profitability of different sectors and assess which industries will perform well or poorly.
Emotions can intensify our perception of events. For example, rising share prices can make us feel more optimistic or excited. If a stock keeps climbing for several days, it can create a general sense of optimism, leading the media and participants to search for reasons for the rise and discuss them extensively. For instance, excitement about AI (artificial intelligence) has driven up the stock prices of AI server suppliers and tech giants, which can also boost other stocks in the same industry, even if they are not performing as well.
Company Performance
Investors evaluate a company’s growth and performance prospects. During the pandemic, high expectations for Tesla and the electric vehicle industry led to significant share price movements even when sales growth slowed.
However, company performance can also be influenced by emotions, such as overconfidence., Overconfidence can lead investors to ignore warning signs of a downturn. Emotions can also affect how investors react to news and events, such as earnings reports, product launches, or lawsuits which can have a positive or negative impact on share prices.
Share Price Trends
Investors predict share price movements based on trends or quick reactions, such as technical analysis or momentum trading. Daily market reactions and stock price changes can affect emotions, leading to impatience during stagnant periods or Fomo (fear of missing out) during continuous rises.
While emotions themselves do not directly move share prices, they influence investor behaviour, which can result in price changes. A wave of optimism can lead to increased buying, driving prices up (sometimes resulting in bubbles), and fear can trigger widespread selling, pushing prices down. Emotions influence investment decisions at various levels when regular investors are more likely to be affected by emotions.
Practical Tips for Investors
After hearing how emotions can influence investment decisions, here are some practical tips to avoid this:
- Engage an investment adviser to help ensure you remain focused on your longer-term goals. This gives you someone to bounce your ideas off and help you see reason, rather than being driven by your emotions.
- Reduce your exposure to direct shares: This is a wise approach if fluctuations in share prices are causing you stress. Additionally, consider moving investments to bonds to secure yield or to diversified funds. This strategy can help mitigate risk, provide greater peace of mind in volatile markets, and offer more stable returns.
- Adopt passive investment strategies: Regularly invest in index-tracking exchange-traded funds (ETFs) to mitigate risks and volatility through diversification while benefiting from long-term market returns. Once you become comfortable with market fluctuations, consider allocating a portion of your funds to active investments for the potential to gain additional return.
- Keep a trading journal: record your reasons for trading and your emotions each time. Observe and document your actions. If you identify mistakes later, it will remind you not to repeat them. This helps you become aware of your emotions and improves your decision-making.
- Evaluate existing holdings with the same rigour as new investments: regularly review your current portfolio with the same critical eye you would use when considering a new investment. Avoid the trap of not selling underperforming stocks simply to avoid acknowledging a loss. By objectively assessing your holdings, you can make more rational decisions that align with your long-term investment goals.
While we can’t eliminate our emotions, investors can aim to recognise and manage their emotional impacts. By becoming aware of these emotions, you can make better investment decisions.
Seeking advice from a professional wealth adviser can also help manage emotional decisions. This shift can help you transition from a panicked “prey” to a calm “hunter” in the stock market, allowing you to compete more effectively with other market participants.
DISCLAIMER: This research has been prepared by Jarden Wealth Limited (Jarden) which holds a licence issued by the Financial Markets Authority to provide a financial advice service. The information in this research solely relates to the companies and investment opportunities specified within. For a full publicly available disclosure statement, see https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement/.
