Keeping Fear, Frustration and Joy Out of Your Stock Portfolio
David S. is a senior at Bergen County Technical High School in Teterboro, N.J., U.S. A lover of all-things finance, David competed in Region 3 of the 2018 Wharton Global High School School Investment Competition. Of all the lessons that David and his teammates took away from their competition experience, the influence of emotions on choices for their investment portfolio was especially powerful.
Virgilio Aquino with Aberdeen Standard Investments in Philadelphia, Pa., has reminded us that “When choosing stocks, logic and common sense should drive your decision process. Sometimes emotions can trump common sense. Don’t let your emotions drive your decisions, but rather your own research. You have to have your own assumptions, and in order to have good assumptions, you must do your research.”
In this personal essay, David S. confronts his emotions head-on, with advice for his fellow traders on keeping the fear and elation in check. Do you agree with his ideas? Be sure to provide your own perspective in the comments section of this article.
How do successful investors navigate the stormy seas of the markets? Most rely on somewhat objective textbook methods of investing. However, stock traders are an emotional crowd. Worldwide, there are millions of traders, just like you and me, constantly buying, selling, while driving prices up and down. We’re traveling on our own emotional rollercoaster of fear and hope. How do we become successful traders without letting these emotions impact our profits?
These investment demons haunt me periodically, as well. From loading up on a losing stock until it hits the ground, to holding on to a profitable trade until it turns around, I’ve learned that trading is as much a game of knowledge as it is of self-control, discipline and rational thought. With more than 400 teams participating globally in the 2017-2018 Investment Competition, how should the thousands of participants be mindful of their emotions? Here are a few suggestions.
- Over-attachment & Excuses. It is unwise to create excuses for most situations. This is certainly true in the markets. Even with a long-term mentality, you shouldn’t always make these excuses for losing stocks. A common scenario is a trader who gobbles up a stock all the way to the ground floor (or bankruptcy court, if you’d like). After painstaking fundamental/technical analysis, the investor believes the company’s stock will go up and becomes emotionally attached. When the tides turn, however, the investor is too stubborn to reevaluate the situation, and he buys more shares. Finally, the stock sits significantly lower than the trader’s entry point and takes up a large portion of the portfolio. In late 2016, for example, I felt extremely strong about Abercrombie and Fitch (ANF). With solid technicals and fundamentals, I believed it to be a value stock — a tough find in a bull market! Month after month, however, the price was heavily depressed and hit a low of $8, from my initial “buy” recommendation at $14. Was I really wrong? Not necessarily — almost a year later it hit $14 again. But is it worth waiting one year to simply break even? You need to consider all the angles, emotion-free. Reevaluate the situation and do not marry your trades!
- Bending the Rules — Rules and discipline are extremely important concepts both in life and trading alike. If you have your own rules in the markets, such as stop losses, use your best judgment when trying to adjust them. After all, are they really rules if you make exceptions? My high school business teacher told me (more times than I can count) — “pick a strategy and stick to it”. Create a plan for each trade and be disciplined, rational and honest. If a stop loss is hit, cut the trade. If it hit one of your profit goals, then exit the position. In mid- to late-2017, I was short on crude oil after looking at some fundamental and technical factors. Long story short (pun intended), this trade was not very profitable, as oil jumped from $40 to $60. Do not be afraid to be honest and disciplined with yourself.
- Excessive Risk — One of the most common tenets of investing is diversification. Don’t put all of your eggs into one basket, right? Some investors, hoping to make up for their losing positions, or simply looking to increase their risk/return profile, use excessive leverage or overload their portfolio with a single position. Their analysis is often one sided — there’s an opportunity for high profits, but also astounding losses. At one point in my trading experience, I decided to “play around” (invest wouldn’t be the proper terminology) with penny stocks. After putting a large chunk of my portfolio in a company that makes thin LED light strips for cinemas in Arizona, I lost more than 50% of the investment in 40 minutes. All investments have risk, and high-risk investments should not be avoided at all times. Excessive risk, however, can be reckless.
- Running against the Crowd — The markets are compilations of two opposing crowds — the bulls and the bears, both driven by greed and fear. Fundamental and technical factors are often secondary to the emotions of the traders and the strength between the two groups. Moments of irrational exuberance, manias, and bubbles, depressions, and crashes are often uncorrelated with the real value of the markets. Once fear, along with greed, steps in, fundamentals are no longer considered. A trader could develop stubbornness — “the markets are wrong and will eventually come back to their senses.” Could any kind of fundamental analysis from a single trader really influence the direction of the crowd? Almost never. I’ve tried fighting some markets that I thought were fundamentally overvalued, and learned that the countertrend is sometimes too strong. I believe it’s best that you don’t fight the crowd — either go with the trend or simply don’t participate. “The markets can remain irrational longer than you can remain solvent” — John Maynard Keynes.
- Burnout — Trading is difficult, and most investors are prone to burnout. Burnout pushes individuals to potentially deliver subpar analyses, or make compulsive trades. After stress-filled trading, some investors are simply incapable of making rational decisions. Worse, a losing streak often magnifies the impact of burnout. Therefore, traders should know when to stop, get some rest, and refresh their outlook on the markets. Let the markets marinate and move around for a couple of days (or even weeks, depending on your strategy) and then revisit. Investing is a marathon, and not a compulsive sprint.
- Bonus: How to Overcome Emotional Trading — Emotional trading happens to all investors, all the time. The key, however, is to limit it. Set for yourself some objective rules, such as stop losses that cannot be altered. Also, don’t forget the flexibility of being an investor/trader — will it really hurt to skip a day now, for more rational trading later? Overall, try to maintain a journal of rationale used to enter a trade, stop losses, and some goals for your trades. For example, ANF seems like a strong company given its change in management, turnaround in the retail sector, and bullish technical behavior with a stop loss at 21.50, with a goal of long-term growth. Take trading one step at a time, listen to your gut, learn the markets, and be mindful of your emotions.
Related Links
- Investopedia: How to Avoid Emotional Investing
- Aberdeen Asset Management U.S. Headquarters
- Money-U.S. News & World Report: 13 Ways to Take the Emotions Out of Investing
- The Wall Street Journal: How Your Emotions Get in the Way of Smart Investing
Conversation Starters
Do you have any other advice for aspiring traders to battle their emotions?
What factor matters more — industry/market knowledge, or a reliable gut feeling about stocks?
How do you think emotional trading will change given the enhancements in algorithmic technology? Can (or, will) computers get emotional?
I really enjoyed reading through the article. Having read some other pieces on behavioral finance, I agree that conviction and disciplined adherence to a well conceived investment strategy (driven by fundamentals and sound technicals) is key to investment success. In this crazy market volatility, one can easily become vulnerable to biases arising from overconfidence, rear-view mirror thinking, and loss aversion.
Sohil Varshney
Any other advice I would give to other stock traders is to relax and relieve there stress by doing some exercise to not worry too much about their portfolio. I believe a knowledge in the industry is more important than a reliable gut feeling because one could determine the outcome more precisely with the use of their knowledge of that sector to buy the stock which will hopefully turn out a profit. I believe that algorithmic technology will change due to many traders facing emotional trading thus shifting the market in a sense. This will cause computers to be emotional to understand how people’s emotions work.
As someone that has traded stocks, both real and virtual, I can understand the effects of emotional attachment to certain investments. There have been multiple times in which after looking through many different technical strategies I decided that a company was a worthwhile investment, and luckily, while they did have a dip, I held and eventually broke even. Was it worth the time? No. However, I feel like it is necessary to remove feeling from stock trading, but on the other hand, many companies can be affected by how people “feel” about it, so there must be a certain balance.
Especially for those who are investing in the companies that are listed in the S&P 500, the biggest lesson that I learned was buying at an appropriate price, and just leaving it there without looking at it. Analyzing the trend since the 80s values for the different stocks have always been increasing, and there is no significant reason to believe otherwise. Even through such crisis including the 2008 market crash, stock prices have substantially increased. Really, for these types of investors, there is not much reason to panic over when the market is down as it is bound to climb back up. Trust me, save yourself a little stress and put your phone away. However, for those day trade investors, this rule would not apply is that particular strategy would require constant attention.
Another lesson that I learned through investing experience is suppressing greed. When the market is up, and you are making large sums of money, it is quite easy to get distracted from reality. A professor at the Marshall School of Business at USC during an 8th grade visit to my cousin once told me that the best investors who know how to limit themselves. It is so easy to fall into the mindset of “oh, I just made a 30% profit today, this means that I can grow this investment into a 70% profit next week.”
When it comes to investing, emotions can play a big part in a poor investment decision. The saying that fear and greed rule the market is quite true. Investors should not let fear, frustration, or joy control their judgment. Instead, as this essay mentions, investors should focus on the bigger picture or the long run. Stock market returns may deviate violently over a short period, but, in the long run, a portfolio’s returns should not vary much from its averages.
However, despite emotions being a significant factor, overall understanding and insight should be a greater one. With or without emotions, decisions still must be made, and the impact of these decisions are the same whether it is winning or losing. Like the example brought up in the essay, despite feeling very strongly about Abercrombie and Fitch (ANF), the depression occurred. If emotions were not attached, not much would have changed, just disappointment that would quickly dissipate contrary to a little longer. Instead, staying rational and focusing on understanding the investment will make the difference. The world’s most successful investors caution against investing in companies whose business models we don’t understand. By thoroughly understanding each company’s stocks before we invest in stocks, we can avoid the pitfalls.
Yet, despite this advice, truly understanding a company is very difficult, if not impossible. The small, but ever-so-significant details overlooked, can make just as significant differences. These hard-to-detect differences are inevitable. Even some of the most successful investors, such as John Paulson—who found much success in 2008, but also experienced much loss in the past few years—can miss these details, not to mention the vast majority.
For most people, trying to beat the market is like mission impossible. So rather than exhausting one’s precious time and effort, the wise strategy is pursuing average return and following the market index. This way, we seldom get the short(pun intended) of the stick. Nonetheless, if you wish to be part of the minority, and as do I, I bid you good luck.
David’s experience with the stock market—especially his points about over-attachment, excessive risk, and burnout—is strikingly similar to my own experience, not as an investment trader, but rather as a figure skater.
I have dedicated my entire life to figure skating. Like many other 5-year-olds out there, I too was entranced by this sport after watching Yuna Kim land a beautiful triple lutz during the 2010 Winter Olympics.
As a figure skater myself, I can confirm that the TV falsely glorifies a grueling sport that is surrounded by physical and mental hardships. The sport does have its ups, such as the overflowing happiness I feel when I finally land a jump after falling hundreds and hundreds and hundreds of times. But that happiness is instantly crushed after I try the same jump just one more time and end up falling back onto the ice. This is the process of learning, but from one point onwards, skating no longer became something I looked forward to.
David warns us not to get over-attached and make excuses. He was talking about the market, but I really could’ve used that lesson in figure skating. I was emotionally attached to a distressing sport along with my own stubbornness and ego. Because I started skating at a young age, just like most people, I hated being told that I was wrong. This innate flaw of mine caused me to always butt heads with my skating coach. Her words would constantly go in one ear and out the other. On the rare times I actually applied her guidance to my jumps, my jumps would feel risky which prompted me to just fall back into my old habits. At the time, I basically thought she was ruining my jumps, but now looking back, I was just a stubborn child who didn’t accept the help of others. David mentions that excessive risk can be detrimental, but in my case, I wasn’t taking as much risk as I should. Just like the stock market, skating involves a great deal of risk. Changing your technique could either end on a positive note, where you start to land every jump consistently, or it could take you to the other end of the spectrum, where you do nothing but fall. Like an investor afraid of financial loss, I was a figure skater who wanted change but was too afraid of it, leading to a deep feeling of dissatisfaction and fear. I continued to blindly rehearse my old techniques, and after months and even a year of seeing no improvement, I had no one to blame but myself.
Like the situation in the article regarding the Abercrombie and Fitch stock, where David advised readers to “Reevaluate the situation and do not marry your trades!”, I was essentially married to my stubbornness. During the pandemic, I was forced to take time away from the ice, and in the course of this break, I started to idolize Nathan Chen. After suffering a terrible hip injury in 2016, Nathan was forced to relearn and recover all the skills he had lost due to his time away from the ice. Despite this setback, he not only recovered his skills but also went on to win the Olympics, setting numerous world records in the process. Nathan Chen’s journey encouraged me to reevaluate my own situation, which then prompted me to finally divorce my stubbornness. Now with a new mentality, I was dead set on relearning all my jumps with the correct technique. This forced me to start back at the beginning, similar to how David waited one year just to break even. I went back to the basics, starting with single jumps, and then slowly moving my way up to the triple jumps that I had always struggled with in the past. This time around, I wasn’t afraid of change or risk. My changed mindset resulted in an astounding amount of improvement, which led to my most successful figure skating season to date. It took months to relearn all my skills, but just like how David says that investing is a marathon, skating too is also a marathon that requires dedication and patience to see results. My high school business teacher always emphasized that the higher the risk, the bigger the reward. Despite how cliché it sounds, after avoiding and taking risks over my 10-year-long figure skating journey, I can say that high risks truly do come with high rewards. Whether it’s learning on the ice or learning about the stock market, in the future, I will keep David’s words in mind about the importance of reevaluating a situation and not letting stubbornness hinder my opportunities/mindset.