Sunday, 18 Nov 2018

These 5 biases can make you your own enemy while investing in stocks

201826Apr

Your large-cap stocks rose steadily, the mid-cap picks doubled in value and the small-caps turned multibaggers. What’s the secret behind these enormous returns? Was it indepth research, prudent stock picking, impeccable timing or just pure luck?
However, this panic buying can be ruinous. Even a good scrip is a bad investment at a high price. The rise in stock prices has enriched investors, but expecting the Sensex
Many small investors might want to tick the first three options, though in most cases the fourth answer could be a more accurate explanation. The rising tide of stock prices lifted all boats, including many leaky ones. With markets touching new highs, here are five ways how investors become their own worst enemies.


Fear of missing out The fear of missing out (FoMo) factor comes into play when you see everybody and his uncle making big money in stocks. Gripped by the regret of staying away and pushed by the desire to catch some piece of the action, fence sitters and newbies jump headlong into the market. Suddenly every stock looks worth buying.


to continue on the same trajectory forever would be akin to driving by looking into the rear view mirror. Just keep in mind that you won’t miss an opportunity of a lifetime by not investing now.


Overconfidence is a dangerous feeling in the stock market. Investors who are less confident tend to make fewer mistakes than those who are brash and carefree. Human biology plays its own tricks here. When a trade goes right and an investor makes money, the brain releases dopamine in the body, which makes the individual feel positive and more confident of doing well.

Dopamine is addictive and makes people feel positive, confident, and energetic. The bigger the anticipated rewards, the more dopamine is released by the brain, pushing the investor into a vicious cycle. Remember this when you are placing your next ‘buy’ order.


Mental accounting Behavioural finance tells us that people are more willing to
risk money earned the easy way. In gambling, this is known as ‘playing with the house’s money’. If an individual wins money in a casino, he is more likely to gamble with it than pocket the amount. He doesn’t see the winnings as his own money but treats them as if they belong to the casino.

 

 
This is also why many casinos let customers win periodically. The big gains earned over the past 1-2 years could make investors fall for this behavioural bias. They are more likely to put their gains into risky bets now. A prudent investor, however, will overcome this emotional bias and deploy his money in safer avenues.

 

 


Anchored to a price Investors can also hurt themselves by getting anchored to a price point. Many midcap and small-cap stocks had run up quite a bit during the rally. Now they have receded a bit, possibly 10-15% from the recent highs. This is a good time to book profits in these scrips. It will be a mistake if you wait till the stocks regain the 10-15% lost ground and reach their previous highs. That may not happen immediately and you might miss the decent profits you can make by exiting at current levels.

 

 
It’s different this time Lastly, beware of the five most dangerous words on the stockmarket:
It is different this time. Even as stocks rise, small investors continue to make the same mistakes. Don’t get misguided by the euphoria on the markets. The current rally is looking unstoppable, but the market cannot (and will not) continue on the same trajectory forever. Entering a stock at a high price can burn a hole in your portfolio. The situation has not reached an alarming level yet, but many analysts have sounded notes of caution. Small investors would do well to take heed if they don’t want to become their own worst enemy.

Courtesy: TOI January 29, 2018.

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