What is Emotional Investing?

Emotional investing is a very simple concept, but controlling it is very difficult to do. Emotional investing is simply letting your emotions influence the decisions you make while doing any type of investment activity. This may sound strange and you may have not heard this advice, but you should approach investing like a robot. Robots do things through structure, logic, and with mathematical formulas. This is how investing should be approached.

Before we jump into this with more detail, it would be worth pointing out which emotions commonly influence our decision making abilities while investing.

Fear. (e.g. fear of the market going lower.)
Greed. (e.g. Wanting the price to go higher.)
Boredom. (e.g. Not thoroughly analyzing the investment or trading because you’re tired of waiting)
Despair. (Your world crashes down on you if you lose money.)

Because every individual is unique, you will undoubtedly experience your own emotions in addition to these. However, you will surely experience these 4 emotions in some fashion throughout your investing journey.

Why is Emotional Investing Dangerous?

Investing requires you to act in a mathematical way. Your emotions will cloud your judgment. The reason that emotional investing is dangerous is because what you are supposed to do is opposite of what you want to do. You will understand fairly easily what you NEED to do, but you will never feel like doing it. This is very dangerous for investors. By removing our emotions completely, you can approach investing through an analytical point of view and see everything clearly. Let’s look at an example.

Greed

First, let me explain the situation. There is a thing called a pump and dump. A pump and dump is when a lot of money is thrown into an asset, and everyone get’s really excited so they start buying into the asset. This causes the price of the asset to become very expensive very quickly. Then very quickly, at a point unknown, the big investors that started the pump and dump pull their money out. This allows them to make a lot of money from the little investors that don’t know what they are doing.

Naturally, when someone sees a pump and dump, they want to jump in. Why? Greed. They see that the asset has gone up 34% in the last 5 hours. The investor, in their greed, convinces them that there is enough momentum that it will keep going up. So they put money into the asset, and the asset remains fairly stable for about an hour. You can see the asset fighting to get higher, so your greed convinces you that there is more money to be made. Then, a few moments later, the stock goes down 10%. You’re not going to give up, you see it inching back up slowly. Then it drops another 20%. Your heart is pounding and you can’t believe what just happened. You sell everything and get out.

This is just 1 scenario. We focused on greed, but this type of scenario could easily happen with any of the other emotions. What would happen if we remained absolutely emotionless throughout this entire process? You would never enter because you know you’re too late. You would ignore your greed, and you wouldn’t have lost money.

Fear

Let’s look at one more example. You have a lot of money invested in a mutual fund. Your assets have been performing well for the last few years and you’re feeling great about yourself. Then out of nowhere, something happens in the world that causes the population to become fearful. No one saw this coming. Overnight, the stock market plummets. You end up losing thousands of dollars in just a few hours. Although you have a few hundred dollars uninvested and sitting in your brokerage account, you decide to act out of fear. The stock market could go even lower, you say to yourself in fear. You must protect what you still have, you say to yourself in fear. So you sell everything. Over the next 2 – 4 weeks, the market recovers. You finally feel safe again, so you buy your assets back.

If you removed fear from this situation, how would things be different? You would remember the concept of buy low and sell high. You would remember that the stock market act like waves in the ocean. So naturally, you would understand that this is the time that you’re supposed to buy. Once the stock market crashed, you would have put your available cash into purchasing additional assets for a discounted rate.

By the way, don’t dismiss this as a hypothetical. This happens all the time.

So, How do you Replace Emotional Investing?

Take emotion completely out of the picture. Instead, you should use logic only. Become a robot. If you lose money, you should act like it’s a game of monopoly. No one cries themselves to sleep after landing on someone else’s property in monopoly. Investing is just a game and emotion has no place in this game. A robot does not contemplate how it should feel. A robot just retrieves it’s programming and data and responds appropriately.

Once you become a robot, you’ll begin to rely on your understanding and knowledge about investing. Once you get to this point, you have won a huge part of the battle to becoming a profitable investor. Emotional control is one of the most difficult parts of investing. After you master emotional control, all that is left is mastering the technical aspect of investing.

How Do You Overcome Your Emotions?

There are a few answers to this.

Automation. By using automation, you can remove yourself from the investing process to a certain degree. It’s easy to act like a robot when you literally have robots do it for you. A few simple ways to begin automating your investments is by setting up automatic transfers of money to your brokerage account and by using various order types such as a limit order which removes you from the purchase and sale of the asset.
Experience. Have you ever been inside a casino? It’s fairly obvious by watching people at a casino who go regularly and who rarely go. At a casino, the regulars are crouched over on the game, smoking a cigarette, and they look very comfortable like they have been there for hours. They usually look bored or like they don’t really care. However, a first timer is walking around smiling, pointing at all the fancy chandeliers, and has an obvious excitement to them. By gaining experience and exposing yourself to a lot of situations in the stock market, you will naturally lose some of your emotion. It’s just another day and the stock market isn’t that impressive. Why bother caring?
Mindset. If you develop a mindset to approach the stock market like a robot, you will free your mind of some of the pressure of your emotions. Creating a good mindset about investing definitely helps.
Technical skill. The more you understand about the financial markets, the more you’ll understand how they work. Once you understand how things work, the magic kind of disappears.

If you can combine all of these various ways to overcome your emotions, you’ll eventually stop participating in emotional investing. It’s definitely possible, but it’s not the easiest or fastest thing to achieve. However, if you want to be a great investor, you need to begin working on this as soon as possible.

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