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How emotions can impact your investment decisions

By Angelique Ruzicka

15:11, 17 January 2022

Man covering his face looking at chart with downward forecast
Don't make trades when you're emotional; Photo: Shutterstock

The trading pits of the city were notorious for running on high emotions. Traders were constantly shouting numbers at each other, always seemed on edge, and emotionally charged.

Of course, COVID-19 put an end to open outcry trading pits where it was typical to see traders in close contact, pushing and shoving.

Nowadays, trading can be done remotely from the comfort of your own home. But whether you’re a professional trader, just looking to take a punt, or if you’re investing long term the emotions are still there and they could play a big part in what we buy and sell.

It doesn’t really matter what emotional state you’re in. You could be happy or sad and still make bad investment decisions. But why can emotions be the enemy?

Selling in a panic

A common emotion we experience when trading or investing is panic. If share prices are tumbling, it’s hard not to get upset and sell to preserve what capital we have remaining.

But making an investment decision when you’re panicking will often end in tears. We recently witnessed the consequences of making panicked financial decisions at the beginning of the COVID-19 pandemic in March 2020.

“Many investors bailed out of the equity markets at the lows only to re-enter the markets after they had advanced significantly from the lows. Making panicked decisions results in investors selling low and buying high,” points out Robert Johnson, professor at Creighton University and CEO at Economic Index Associates.

Buying when you’re happy

It may not sound possible, but you can make the wrong decisions if you’re in a positive mood too.

Happiness is an emotion best harnessed when you need to engage in new projects or perhaps even to discover new potential investments. But before you put your money down, make sure it’s not based on the current bliss that you feel.

“While a healthy dose of optimism can certainly help, ideally you want to keep an even keel. You don’t want to ride too high or too low. After all, markets have no emotion about you, and you shouldn’t have emotions about them,” says Frank Murillo, partner and managing director of Snowden Lane Partners.

How can you take the emotions out?

It’s difficult keeping emotions at bay, but it’s not impossible. There are various strategies you can adopt to ensure you don’t make decisions when you’re at the mercy of your emotions. They include:

XRP/USD

0.64 Price
-0.350% 1D Chg, %
Long position overnight fee -0.0753%
Short position overnight fee 0.0069%
Overnight fee time 22:00 (UTC)
Spread 0.01168

Oil - Crude

70.08 Price
+0.860% 1D Chg, %
Long position overnight fee -0.0205%
Short position overnight fee -0.0014%
Overnight fee time 22:00 (UTC)
Spread 0.030

Gold

2,033.57 Price
+0.350% 1D Chg, %
Long position overnight fee -0.0196%
Short position overnight fee 0.0114%
Overnight fee time 22:00 (UTC)
Spread 0.50

US100

15,838.80 Price
+0.280% 1D Chg, %
Long position overnight fee -0.0263%
Short position overnight fee 0.0041%
Overnight fee time 22:00 (UTC)
Spread 1.8
  1. Sticking to a plan

One way to keep the emotions out of your investment decision is to create a plan and stick to it. This should be based on an Investment Policy Statement (IPS).

Johnson explains: “An IPS is a written document that clearly sets out a client’s return objectives and risk tolerance over that client’s relevant time horizon, along with applicable constraints such as liquidity needs and tax circumstances.

“In essence, an IPS sets out the ground rules of the investment process – it is the document that guides the investment plan. Included in that IPS is a target asset allocation. The IPS should include a glide path for target asset allocation changes as the individual ages.

“All investors should have an IPS. And, it is best to develop an IPS in a rather calm market. Developing an IPS in a volatile market or during major stories is problematic.”

The point of an IPS is that it guides you through changing market conditions. The wrong thing to do, would be to alter it because of market fluctuations. Of course, it shouldn’t be set in stone.

Johnson adds: “It only needs to be revised when your individual circumstances change - perhaps a divorce or other unanticipated life change.”

  1. Work with a professional

If you make investment decisions alone it can be harder to keep your emotions at bay. However, consulting a professional financial advisor can help to ensure that you keep your emotions in check and remind you to stick to your IPS.

“Working with a trusted financial advisor can help you see extremes in a historical context and work through times when emotions tend to take over. Sticking with your investment plan in tough times and overcoming emotions is paramount to long-term success,” says Ryan Johnson, director of portfolio management and research for Buckingham Advisors.

  1. Getting in the ‘zone’

Many concur that the only state of making decisions is a flat state with no emotions. Marcus de Maria, CEO of Investment Mastery, says one way to get your head straight is to get into a routine.

“I know a Dutch trader who always walks with his dogs, then reads out his trading plan, turns on classical music, and is ready to trade for three to four hours that day. He might make 40 to 50 trades in that time. If he feels tired, he stops immediately. Tomorrow is always another day,” he says.

Read more: Self-described ‘investment experts’ likeliest to panic sell

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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
Capital Com is an execution-only service provider. The material provided on this website is for information purposes only and should not be understood as an investment advice. Any opinion that may be provided on this page does not constitute a recommendation by Capital Com or its agents. We do not make any representations or warranty on the accuracy or completeness of the information that is provided on this page. If you rely on the information on this page then you do so entirely on your own risk.

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