DO/DID YOU KNOW
WHO YOU ARE?
In our Do or Did You Know? blogs we provide readers with useful information that is generally not widely realized by inexperienced investors. In Chapter 1 of our publication, When to Buy and When to Sell: Combining Easy Indicators, Charts, and Financial Astrology (available on Amazon), we introduce the concept of Human Emotion as the driver of Market Sentiment. In this edition we will dive deeper into “self-awareness.”
You have probably heard many times by financial advisors, professionals, hedge-fund managers, and traders, that it is very important to display no emotion when purchasing, selling, or trading assets. Easier said than done…
Have you ever received a “hot” stock tip, and could not wait to jump onto your brokerage account to buy shares, without any research? As we discuss in the publication, this is an example of FOMO (the Fear of Missing Out), when an individual will buy based on an emotional response to a rising asset or promising new idea. Sometimes this decision can be lucrative, but most often it fails miserably. The reason it usually fails, is that by the time a stock or investment is being “hyped,” it has already gained significantly and is vulnerable to a “sell-off,” leaving the late-comers holding the bag (also known as exit liquidity). The equally dangerous emotion, known as FUD (Fear, Uncertainty, and Doubt) then kicks in, causing the investor to panic sell to avoid further losses. Unfortunately, this occurs constantly in the stock market, and the experienced will take advantage, including some influential individuals who “pump and dump” stocks. So how does one avoid making quick, rash, decisions based on hype and emotion?
The first, and most important, factor is to “Know Who You Are.” When deciding to become a stock trader or investor (which includes homeownership, flipping assets, and collectibles), it is important to first determine which personality type you possess, and therefore, what type of trader or investor you wish to be. Am I conservative, or a gambler? Do I prefer long or short term? What is my risk (or pain) tolerance? Am I level-headed in an unfavorable situation? Am I patient or fidgety? Do I have a plan/strategy or am I scattered? These are all questions one should ask themselves before managing their own investments or trades. Let us review some scenarios…
For a long-term/passive investor, the plan is rather simple. “Buy and Hold” (also known as HODL – standing for Hold on for Dear Life), which usually includes those with 401k’s, pensions, or long-term real estate holdings. These types of investors generally are not active traders and allow their investment to grow over time. Aside from choosing a potential piece of property to purchase, they are not involved in the choice of which equities to enter and exit, which are usually under the control of a fund manager. Emotions are easy to keep in check under these conditions, as there is no involvement in the day-to-day gyrations of the market.
Stock market investors and traders with limited experience, who manage some, or all, of their stock transactions, generally fall into two categories. Those who only intend to hold positions long-term can also escape most of the emotional effects of a gyrating market, so long as they have a plan that they adhere to. This includes those who simply add to their positions periodically, regardless of market conditions, and usually consists of dividend and growth seekers. Most investors who fall into this category have an idea when they would like to retire, and do not wish to withdraw any funds prior to the appropriate time. It is still important to know your tendencies and risk tolerance, so fear does not play a role during market corrections. Be sure to use only disposable funds that do not interfere with your regular life expenses.
The second, Short-term/Swing traders often have a much different outlook, as they are trying to take advantage of cycles and periods of directional price movement in the markets. Whether they trade long or short, stocks or options, or futures, it is imperative that risk management and emotional control are employed. These types of trades generally last a few days to a few months, with the investor buying and selling more frequently than the long-term individual. Therefore, the plan differs in the way one approaches each trade, and requires much more discipline.
Day-traders are another breed altogether, as they attempt to “scalp” the market for gains during intra-day ebbs and flows of price action, sometimes minute by minute. This type of trading takes exceptional emotional control, and the ability to take losses without panicking, or changing their strategy/system. It is not advisable to attempt this type of trading without practicing or “paper-trading” first, and starting with very low position sizes.
So, which type are you, and what type of investing or trading suits your personality?
Personality Types:
Patient/Unemotional – An individual who is rational, patient, and has total emotional control can ultimately become a good short-term, or even day trader. As noted, this type of trader possesses the ability to handle losses (defeat), without upsetting themselves or questioning their style/approach, even after a losing streak. They stay consistent, continue to work hard, and are truly unaffected by negative trades. They stick to their rules, without ever changing their risk levels, continue to learn, and work with probabilities and percentages over time.
Impatient/Emotional – This type of investor or trader tends to over-trade, and/or attempts to make up for losses as soon as possible, often straying from their general plan or approach. This individual is not suited for swing or day-trading, as they tend to “jump the gun” based on every news report or short-term move against their expected direction of trade. It is best for this type to leave their portfolio in the hands of a fund manager, or educate themselves on ways to understand and control these emotions.
The Gambler – The “Gambler” is the individual who will hit the casino and “let it ride.” (as also discussed in our publication). This type of investor/trader tends to have no solid plan, and pays no attention to fundamentals, risk, position size, or technical analysis. They will take every “hot” stock tip with the fantasy of becoming rich in a hurry. Some do not wish to take the time to understand their investments, or trades, and play it like the lottery or a roulette wheel. This approach has a very low rate of success, though one can occasionally get lucky. For those who prefer this style, it is wise to use only discretionary funds, and very low position sizes.
Passive – This type of individual has no desire to be involved either in their investment decisions, or the process of learning how to invest or trade. They are best suited for long-term funds, including 401k’s and pensions, that are managed by others. They are willing to pay the expenses tied to having their portfolio managed, and may be untrusting of themselves financially (though not necessarily).
So, to review, it is very important to determine which type of personality you possess, and be honest with yourself. All types of investors can make or lose money, depending on how they approach their financial future. The more you understand yourself, the more you can adjust for success.
*** This information is not intended to be financial advice, and should be considered or any specific buy or sell recommendation, but rather a guide to assist the reader in some further understanding of the financial markets.
