5 Investment Psychological Traps and Ways to Overcome Them – Part I

5 Investment Psychological Traps and Ways to Overcome Them – Part I

Classical Economics states that we are rational decision-makers. But we have proved it wrong, haven’t we? 

This is particularly true in investments where many people have shown nothing short of absurdity. 

This absurdity has brought in a popular concept called Behavioral Investment

In layman’s terms, behavioral investment is a combination of psychology and investment. It covers a lot of important psychological traps that many investors fall into often.

Psychological Traps:

  1. Disposition Bias (I have fallen for this many times!)
  2. Fear of Regret
  3. Illusion of Control
  4. Confirmation Bias
  5. Anchoring

Most Common Psychological Traps

1. Disposition Bias (I have fallen for this many times!)

Don’t you want to earn your profits as soon as possible? Don’t you want your losses to turn into profits in the future?

This is exactly what causes Disposition Bias. When the price of our stock increases more than the price we paid for, we want to gain the returns as soon as possible. It is to avoid the possibility of its price falling down later on.

Similarly, when the price of our stock drops below our buy price, we tend to hold them to avoid losing. Rather than admitting our mistake in stock-picking, we hope for the market to return to its initial price. 

By holding these stocks, our money gets stuck. In his book Rich Dad Poor Dad, Robert Kiyosaki says that we are unable to make Our Money Work For Ourselves.

Talking about myself, I have held my losing stocks a lot. I don’t like to see negative returns in my stocks, so I wait for them to break even. But, in doing so, my declining stocks have performed worse, and I lost even more than I would have had I sold them earlier.

It’s a big Challenge for me because I’m a Millennial. I am trying to tackle it before it gets too late.


2. Fear of Regret 

As the name implies, Fear of Regret means that we would do an activity to avoid regret not doing that in the future. 

Let’s suppose you have bought some Amazon stocks at $2,000. Then, you see the price increase for the past few days, which has currently reached $2,100.

You might have initially wanted to hold the stock for a long period of time. But you start thinking “Should I sell them now to earn a profit of $100? What if the stock falls to $1,800 later?” 

With all these questions running in your head, you sell them at $2,100 without researching much.

In other words, your behavior was solely based on your emotional situation.

“Invest today or regret tomorrow.”


3. Illusion of Control

The illusion of control occurs when a person believes he has control over an outcome. Practically, this might not be possible all the time.

As human beings, we like to think that we are controlling our life and what happens with it. 

For example, you recently bought some Microsoft stocks at $150. Then, you start to believe that you are able to influence its price movement (when in fact the buyers and sellers decide the prices). 

Providing another example, a lot of gamblers believe that they can win if they roll the dice harder. Rolling the dice in anyways won’t decide the result of the number that will show up. But since people like to be in control of their outcome, their subconscious urges us to control random events too.

By believing that we are able to control the outcome, we risk too much in the stock market. We simply trade too much and under-diversify our portfolio. 

Trading too much leads to high brokerage costs while under diversification results in the risk of losing all our money at once.

This concept is well explained in the Best Investment Book Ever written, The Intelligent Investor.

“Uncertainty is an uncomfortable position. But certainty is an absurd one.”

Voltaire


4. Confirmation Bias 

People try to look for information that supports their belief and ignore those going against it.

Let’s say you plan to buy Coca Cola stocks. then you hear the news that a lawsuit has been filed against Coca Cola that could cost billions of dollars.  

As you were looking forward to buying its stocks, you will ignore the consequences of the lawsuit. You will view it as irrelevant information. 

Why would you do so? Because it contradicts your belief. In your mind, you have already confirmed that Coca Cola is a great stock.

“Ever since I learned about confirmation bias, I’ve been seeing it everywhere.”

Jon Ronson


5. Anchoring

Anchoring involves using past information for evaluating the value of a stock which might be irrelevant now. 

For instance, you had bought the stocks of ABC Co. at $100 five years ago. Disregarding its financial performance over the years, you still believe that the value of ABC must be $100. 

Today, as competition has decreased its profits over time, the price of ABC is at $40. But, since you bought the stock for $100 earlier, you still believe that the price will increase to $100 soon. 

Anchoring is similar to confirmation bias in some ways. Both of them make us miss out on important details about our investments. These details might seem trivial, but the risk of losing is enormous.

“If you find yourself getting excited over any investment based purely on its price, you’re anchoring.”

Jason Zweig 

So which psychological trap do you think is the most dangerous one? Have you even fallen for one of these?

Thank you for reading it till here. The 2nd Part of this Series can be found in the next link. Please feel free to read it if you want to learn about the techniques to Overcome these Biases – Ways to Overcome The Investment Psychological Traps– Part II.

This Post Has 36 Comments

  1. aurashshoja

    I really agree with the first thing you said about the stock market. We put too much emotion when we are investing when in reality we should look at a logical standpoint. What I’ve learned is time in the market beats timing in the market. Also, taking your ego out of investing helps a lot too. I love your page btw, awesome content. I followed you on Instagram as well. Keep it up!

    -Aurash

    1. Pro Investivity

      Thank you so much for your wonderful and descriptive comments.
      Indeed, we do put up a lot of emotions, rather than viewing the stock market rationally. And of course as you said, time is more important than market, well said, Aurash.
      Thank you for connecting with me in Instagram, I’ll see you there as well.

  2. Mary

    Really informative, I have been guilty of all of these at various times

    1. Pro Investivity

      Thank you Mary.
      It’s unfortunate to know that. I hope you have learned valuable lessons from all of these.

  3. Kelvin Paschal

    Nice Article Man !!

    No. 4 is a classic case of What you see is all there is (WYSIATI).
    People neglecting useful facts or evidence because they’ve chosen not to see it on purpose.

    1. Pro Investivity

      Thank you, Kelvin!
      Yup. No. 4 is indeed a very classical case of WYSIATI.

  4. avihappyhub

    Nice article. I have fallen for 1st most of the time. But now I have stopped trading and instead started investing. 🙂

    1. Pro Investivity

      Hey Avi, Nice to see you again! 🙂
      It’s unfortunate to know that.
      But I’m glad you have chosen investing over trading.

  5. Grant Smith

    Great article! I have definitely been at fault with confirmation bias. I also love the line, “A lot of gamblers believe that they can win if they roll the dice harder.” So real and witty, I am definitely going to quote it. What has helped me through all of these biases is an investment plan. I’ve made it in advance and I review it semiannually to make changes, but it hasn’t changed over the last 4 years even with the pandemic. Keep up the great work. I love the content!

    1. Pro Investivity

      Thank you so much for your time and effort for reading as well as commenting in our blog.
      I’m glad that you enjoyed the “gambler” line. It means a lot to us.
      Wow! You are so disciplined, Grant! Even during such a crisis, you can’t be shaken. That’s a great sign of a smart investor! It’s my privilege to be connected with you.
      Thank you so much, Grant! I too love going through your blog. I get to learn a lot about Finance and in particular stock market investments.
      Have a good day, Grant!

  6. Onah Caleb

    Hey Friend,

    This article is superb, touching most aspect of investing while developing self. From now I would start just as as you have stated. Keep this working moving, great jo well done

    1. Pro Investivity

      Hello Friend,
      Thank you for going through the article! I appreciate your time and effort! I believe this article would benefit you to avoid all traps and invest in a proper way. Also, thank you for being well wisher. 🙂

  7. Calvin Ferando

    Everything that you put into this article are solely experiential and self factual! particularly, the 4th one- as I always encounter people who closed their minds and hearts into knowing other truths, aside from the truth that they know.

    1. Pro Investivity

      Thanks for the comment. Yes, Calvin! It’s upon my experience and self factual. I also happen to see the 4th one commonly. I hope you haven’t had to encounter any of them.

  8. Lana

    As someone who studied psychology, and I can agree with this post! Well done 🙂 this is an awesome article on the dark side of investments.

    1. Pro Investivity

      I’m glad that you are able to relate this post with your psychology studies. Thanks a lot on your kind words, Lana! 🙂

  9. Meraki Tacenda

    Hi there!

    This is such a good read for someone like me who’s still got a long way to go understanding the concepts behind stock market. Someone had already influenced me to go into this kind of business, but I still need to read more to educate myself.

    Thanks for a comprehensive write-up tho! 😊

    1. Pro Investivity

      Hi Meraki! 🙂

      Thanks lot for your warm comment. I’m glad I was able to deliver you with valuable content.

      I hope you will find the stock market fascinating just as I do!

      Regards,
      Jenesh
      Pro Investivity

  10. Pingback: How To Start Your Investment Journey With A Bang? – Pro Investivity

  11. SMS

    I used to be able to find good info from your blog posts.

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