Psychology plays a major role in the success of a retail investor/trader. Many retailers have great knowledge about the stock market, know technical or fundamental analysis well and have adequate capital to invest/trade in the market. But one big psychological mistake which many retailers make forces them to lose money in the market.
Answer : The biggest psychological mistake retailers make is their desire to ALWAYS BE RIGHT!
Why does trying to always be right lead to losses?
It might seem counterintuitive at first to most new investors or traders. How can being right cause an investor or trader to lose money in the market? In fact, the more right you are, the more money you can make, right? WRONG! The stubbornness of trying to be right all the time causes a retail investor or trader to lose more money than they can make by being right about their investments or trades.
This doesn’t mean that you should always be wrong in the market! However, when you are proven wrong by the market, it makes a lot of sense to just accept minor losses & move onto your next investment or trade. Becoming arrogant and sticking to your mistakes causes retailers to lose money in the market.
What can an investor/trader do to avoid this mistake in the market?
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You don’t have to make money in every investment/trade
Not all investments are meant to make money for you. Out of 20 stocks which might be present in your portfolio, you would become extremely wealthy if only 10-12 stocks perform in the long run. In fact, if you keep on cutting your losers and let the winners run, you would further increase your rate of return from the market. However, retailers make the exact opposite mistake. They let their losers run while cutting their winners short. To learn more about this, visit the article – Why ‘average’ thinking doesn’t work in Stock Market?
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It is okay to be wrong sometimes
Nobody can predict the stock market. This is true regardless of your capital, power or connections. Even if you work in a big fund, you still cannot predict the stock market. There are countless examples where financial gurus/analysts are hilariously proven wrong by the stock market. Since nobody can predict the stock market, it is okay if you can’t predict sometimes as well. Just take the minor losses & get out. We should always look for better opportunities in other investments/trades.
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A smaller loss is always better than a bigger loss
Most retailers buy stocks without any regard to their exit strategy. They do not exit the stocks when they are faced with a small loss (stop-loss for their investment / trade) because they keep on holding the stock hoping for a turnaround. This strategy for investing/trading is basically gambling where you are hoping for a stock to miraculously turn around & provide you the returns which you were looking for. However, what if the miracle doesn’t happen? Most retailers end up holding the stock until they lose all hopes for a turnaround & end up taking a much bigger loss than what they would have taken if they exited their investment/trading position at the predetermined stop-loss.
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Only risk what you can afford to lose
Having a very big investment position is one of the factors which causes the most stress amongst retailers. Have you watched Dow futures all night in the hopes of a rally because you are stuck with a huge position in some stock? Then it means that your trading position is too big. Having a massive investment position means that even losses which should have been small appear to be huge! This causes an investor to take up irrational decisions which causes them more harm than good. The golden rule for an investor/trader is – Only risk what you can afford to lose!
How can an investor or trader accept their mistake?
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Exiting a losing position with minimal losses
A trader or investor should always exit their losing position with minimal losses. But how do they decide that a trade/investment is a lost trade/investment? The answer is simple – Exit at your pre decided stop-loss! Regardless of whether you are a trader or an investor, waiting & hoping for the stock to miraculously move in your trade direction after the stock has shown every motive to move in the opposite direction is a fool’s errand. The first step in exiting a losing position with minimal losses is to accept that a trade/investment is a losing investment. This involves a trader or investor deciding a fixed stop-loss as their exit strategy from a losing trade/investment. As soon as the stop-loss is hit, you need to exit without any hesitation!
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Not entering a trading position after the move has already happened
Many retailers make the mistake of entering a trade/investment after the price movement has already taken place. Let’s suppose that you are studying the stock where you come to the conclusion that the stock price can rise 20% from the current level based on technical analysis. You are proven right when the stock moves up by 10% the very next day & you buy the stock in panic. Why did you buy the stock after the 10% move had already happened? You didn’t buy the stock to make any money! Instead, you just bought the stock to prove that your analysis was correct.
It really doesn’t matter if your analysis was right or not, the only thing which matters for investors/traders is whether your action is making yourself money or not! Your decision to buy the stock after a huge up move was an emotional, not a logical one. You didn’t buy the stock to make money, you bought the stock to prove yourself right which is a big psychological mistake. Avoiding such panic trades/investments & only focusing on moves where you can make big money is the right thing to do in every market condition!
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Not running after a stock/index during euphoria
A smart investor/trader never runs after the price. Instead, they wait for the price to come to them. Running after a stock/index during the period of euphoria often backfires because retailers end up taking very high risks for a small reward. Even if a smart investor/trader has to miss on a stock because the stock is currently in the phase of Euphoria, it makes perfect sense to do so. It is always better to miss out on potential profits than to make a decision which can lead to massive losses. The only objective for a market participant is to make money in the market, not to prove themselves right by running after the price!
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Understanding that a new opportunity will always come in the market
Smart investors/traders never worry about missing out on potential profits because they always know that a new opportunity is around the corner. Regardless of your investment or trading style (long term, short term or intraday), you will get many opportunities in the stock market because many events which have happened in the past repeat based on the cycle of greed & fear amongst market participants. Having the assurance that new opportunities can (and will) come around, this stops a smart investor/trader from entering a ship which has already sailed!
Conclusion
Trying to always be right is the single biggest psychological reason why retailers lose money in the market. A smart investor/trader always chooses money over being right. Often, you can make money by accepting your mistakes & exiting your losing investments/trades! However, the final decision of trading or investing depends entirely upon the reader!
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DISCLAIMER : I am not a financial advisor. I am not for or against any company which I have mentioned in this article. All the information provided here is for education purposes. Please consult a financial advisor before investing.
Contact me at investmentabshuru@gmail.com
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