Investing can be define as the process of using your cash to purchase some kind of financial service, product, or an item with the hope that the aforementioned will appreciate in value after the purchase. If the appreciation occurs, the buyer then makes a profit. There are certain investment types that are meant to be held for a long period of time before appreciation occurs, such as investing for retirement. All of these can only be possible if the right investing psychology is in place, or possible failure is the wrong one is entrenched.
You don’t have to be a genius to be able to be successful at investing. It is also true that Warren Buffett once said that “Success in investing doesn’t correlate with I.Q. once you’re above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” The salient truth is that successful investing needs an abundance of psychological strength.
It is crucial to understand behavioural finance for a couple of reasons, one being the fact that it can aid one to not making the most common psychological blunders. It can also alert to the negative financial routes others are taking, thus enhancing your stance in a multitude of many.
Most times we find investors hinge their thoughts on the return on investment only, rarely do we find them dwelling on their psychological makeup, as it effectively defines your market performance. It is expedient to say at this junction that every human has psychological biases. This can be literally explained as having specific inclinations and preferences that slows down a person from accessing a situation objectively.
You’ll find these biases present in all humans, while others are specific to individuals in view of their personality and life style. It doesn’t matter how you got this biases, but it is more important how you can comprehend and control them if you must be on top of your game.
Research has shown that although a lot of individuals are of the view that they are firmly rational and objective when carrying out decisions pertaining to investment, this is somewhat untrue. For you to understand this, let’s consider a simple scenario: I have 2 cards (a heart and a spade) covered and I offer to give you $200 if you pick the heart or nothing when you pick the spade and take a guaranteed $100 when you refuse to pick any.
Pick an option before you proceed and try to remember it along the way. If I change the rule and you’re to pay me $200 if you pick heart, nothing for spade or refuse to pick any and pay $100 at once. Now what will your option be?
Well, I’ll help you out here, just like a lot of folks out there that will go for the guaranteed pay out in the first case study but chose to take a chance on the second. This is basically not how a rational and objective person should behave. Both case studies are just identical and as such the choices on each should be the same – that will be in a case where people will act ideally i.e. in a rational and objective manner.
The truth is, individuals aren’t that rational and objective and as such feel different when pitched in a winning and losing condition. As such the varying, irrational decisions.
Some irrational decisions stem from arrogance, which evidently makes us feel that whilst many have lost money doing something, we could possibly be different and make cash out of it. Only experience can be an antidote for arrogance that breeds irrational actions. It is however imperative that our investing psychology does not allow us make the same investing mistake twice.
Contributed by Ivan Lutchkov for FXOpen UK Forex trading company.