When Investing, Emotion Is Not Your Friend

Trading stocks has never been easier.

Nowadays, discount brokers are offering no-commission trades for most stocks. They are also waiving minimum investment requirements. Thanks to trading apps, anyone with a smartphone can trade at any moment of the day. And with the market having made big gains in recent years (before 2022), even folks who previously weren’t interested have started getting involved in the stock market.

I have a good friend who fits that profile of the late comers. He already had stock exposure but it was a passive investment through a 401k. Last year, he decided to assert more control of his investment. If nothing else, it was the fear of missing out (FOMO) that motivated him to start trading on his own.

Emotional Investing Can Be Costly

Unfortunately for him, he happened to decide to invest right near the peak of the S&P 500. Feeling discouraged, he recently asked me for some thoughts. Without getting into too many details, it was evident that he was making a common rookie mistake. He was letting emotions cloud his decisions.

When the market fell, he got scared and sold almost all his stocks. Then when the market started to rebound, he started to get the FOMO feeling again, and bought to try to make his money back. But then the market fell again, and he sold some of the stocks he just bought back. He ended up always chasing market action and got caught on the wrong side of the trade.

During periods of high volatility, when the market makes big swings up and down, emotions can really hurt you, making you sell when you should buy and buy when you should sell.

he best suggestion I could give him was to invest in companies that he understands and likes, and not let market action rattle him. It’s okay to buy in an up market and sell in a down market, but the reason for the trade shouldn’t be because everyone else is buying or selling. Taking a moment to analyze can help steer you away from a knee-jerk reaction that you regret later.

What Buffett Didn’t Say

Warren Buffett famously said: “Be fearful when others are greedy and greedy when others are fearful.”

What he means is that when others are greedy, stocks tend to be overvalued and when others are fearful, stocks tend to be undervalued. It’s related to the idea of buying low and selling high, which is, needless to say, a great way to make investment income.

But what’s unsaid in that Buffett quote is that you still have to be selective.

When others are greedy, you don’t want to just sell your whole portfolio. You should analyze which of your stocks are most overvalued. Conversely, when others are fearful, it creates a buying opportunity, but you don’t want to buy indiscriminately. You still want to selectively buy the best stocks you can find. That’s where due diligence and good research come in.

It’s easy to fall into the beginner’s trap of seeing a stock drop sharply and automatically assuming it’s your chance to buy low.

It very well could be a buy-low opportunity, but you need to find out why a stock is falling.

The Importance of Analysis

If a stock fell due to the company suffering a temporary setback—e.g., a worker strike at a plant—and its long-term outlook appears intact, it is likely indeed a buying opportunity especially if you plan to hold the stock for at least a few years.

But when there’s reason to think that a company’s future is permanently impaired, the stock needs to be downgraded. For example, Sears was a once mighty retail chain that failed to adjust its strategy to capitalize on the Internet, and it eventually filed for bankruptcy.

On the flip side, it’s also important to recognize potentially groundbreaking technologies. Just because a stock is flying, it doesn’t mean it can’t go up even more.

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