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Investing 101: The 4 Most Common Psychological Traps


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Investing 101: The 4 Most Common Psychological Traps

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  #1 (permalink)
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It's been said of life thatwe are our own worst enemies, for the mindless decisions we make, as well as our frequent inability to learn from them. Nowhere is this more evident than on Wall Street, where this enemy from within has a way of making us too confident, too timid, too impulsive, and too staid - sometimes even all at once.

And so, for this installment of Investing 101, we highlight four key areas where your head can be the biggest obstacle to success as we tacklesome dos and don'ts of market psychology.

Anchored in the Past
Oh how easy it is to pick winners with the benefit of hindsight. And yet, one of the biggest blunders investors make is the tendency to make decisions in the rear-view mirror instead of the through the windshield.

"There's always some big recent event that everyone anchors themselves on," says Russell Pearlman, sr. markets editor at SmartMoney magazine in the attached video. "These days everyone is anchored on all the bad stuff that happened in 2008."

Even though that particular fear, or any other fear may be valid, Pearlman says it has caused countless investors to either sit on the sidelines or seek the theoretical safety of Treasuries.

He's certainly not advising investors be cavalier about risk, but he is pointing out the pitfalls of paralysis, saying "what happened in 2008 should not be the be-all, end-all rationale for making an investment or not making an investment."

Confirmation Bias
This trait can be observed both on and off Wall Street and is perhaps the most pervasive mistake we make. As Pearlman says, "this is a behavior that all of us exhibit."

So what exactly is confirmation bias?

"This is seeking out information that confirms what you already know or want to believe," Pearlman says. Apple ( AAPL) is a good example, given its meteoric rise and fervently loyal fan base. A mere mention of something critical about the i-Giant is almost certain to trigger an avalanche of counter-attack, rather than evoke a thoughtful debate. This mindset is dangerous and will ultimately hurt you.

The Thrill of the New
Perhaps it is our ever shrinking attention spans or simply the result of a growing stable of incredibly cool gadgets, but Pearlman sees danger in our infatuation with new stuff.

"Everyone loves new things," he says, "but that can work against you too."

The example he uses here is McDonalds ( MCD), an unbelievably successful company and stock, that happens to also be in the old business of making hamburgers. The advice here is to be open to all ideas, not just ones tied to new things.

Overvaluing Experts
Our last mental trap that can trip you up is, in a way, a shout out to ourselves. At a time when more information from more places moves faster than ever, Pearlman says it is imperative that investors take some ownership in the decision-making process.

"We assume experts know everything," he says, "often in fields that they're not expert in."
This is in no way a slight to all authority or legitimate expertise, but rather a cautionary caveat to stay involved.


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Investing 101: The 4 Most Common Psychological Traps | Breakout - Yahoo! Finance

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Try not have the CNBC or any other news on when trading. Try to be as methodical as you can be. Follow your plan with as much discipline as possible by buying when you get your usual buy signal and going short when you get your usual short signal. Once you are in a trade and have your stop loss and profit taking orders in place, resist the temptation to adjust them.....just let the trade play out.

Believe me, this is REALLY HARD to do! We are human but we need to be as machine like and emotionless as possible to be successful traders!

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