The stock market is usually described as an aggregate of human emotions. The volatility and price swings are a reflection of the prevailing emotion of investors. These emotions exemplified by fear, euphoria, greed, or uncertainty sweep through the market as investors try to make sense of financial data and position themselves accordingly. The irony is that these feelings do not discriminate among investors- amateur or professional. Though investors react to news and data in different ways, most often the market moves in one direction like a herd because the basic human instinct is to seek safety in numbers.
This explains why most people buy when the stock prices are going up, and sell when stock prices are sliding down. These knee-jerk reactions have only resulted in compounding losses. The most savvy investors know that the key to successful investing is mastering your emotions. Investors who are able to zoom out and control their behavioral impulses in moments of volatility can make sound investing decisions.
So how can one stick to his investment strategy in times of turmoil? Here are some tips
Know your investment
This strategy was popularized by legendary investor Peter Lynch but has also been used by the likes of Warren Buffett. It implies that you should only invest in companies that you know. Apart from the obvious benefits of understanding the business model, cash flow, and management principles, it also helps to dumb the noise from the market. If you know why you invested in a company and what you expect from it, it is easy to separate emotions from fundamentals and make your investment decision accordingly.
Have a long term view
Having a long-term view gives one flexibility when it comes to investing. If you plan to hold a stock for 5 or 10 years, then it is easy to accommodate losses in the short term. In fact, a dip in price may be viewed as a buying opportunity. This contrasts with short-term investors and traders who have less margin of error. A price drop would signal alarm bells which could lead them to hit the sell button.
Conduct your due diligence
One major factor which has worked against most investors is the wholesale adoption of the ideas of other people. Most people depend on analysts and professionals for stock picks. This has led to mountainous losses in investment portfolios. Before you invest in a particular stock, it behooves the investor to conduct his due diligence. This entails going through the company’s financial records, analyzing the industry trends, understanding the financial risks and deal breakers. Due diligence leads to a better understanding of the company but also enables you to trust your decisions and not pander to emotional investing. This ultimately makes you a better investor in the long term.
Control your emotions
Emotion is the enemy of investing. According to a 2018 study published in the Journal of Financial Planning, investors who used an investment approach that was devoid of emotion increased their portfolio returns by as much as 23% over 10 years. Just like every fact in life, mastering your emotions is key to successful investing. It helps you to avoid the herd mentality and have conviction in your investment strategy. As the number of retail investors continues to increase, be rest assured that emotions would be the catalyst behind many investment decisions as shown by the rise of meme stocks. However, those who would profit in the long term are those that are able to keep their emotions in check.
Have a contingency plan
No investment strategy is foolproof as there are bound to be unexpected events that would prop up along the way with unintended consequences. As such, it is always advisable to have a contingency plan in case your investment strategy does not go according to plan, this can be done by hedging or investing in other assets or financial instruments. This allows you to better absorb the shocks from price drops and emotions that follow suit. Having a hedge slows the pulse of your emotions and enables you to evaluate the situation with less anxiety because you already have plans to mitigate against potential losses.
Conclusion
It is not uncommon for the market to experience volatility. During times of turmoil, the first reaction of investors is to capitulate and sell their stocks. However, just as fortune favors the brave, the patient investor who can control his emotion would reap the fruits of the stock market. Those who invested when the market bottomed in March 2020 reaped bountiful gains. As an investor, it pays to keep your emotions in check, or at least have a contrarian view. Doing this would enable you to make sound investment decisions.
Photo by Jamie Street on Unsplash
