The five steps of emotional investing and how to avoid them

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It would be just too easy to think that emotional trading mostly happens in times of high volatility, such as a pandemic.


But the risk of incurring bad investing habits is nothing out of the ordinary, experts warn.


According to an analysis carried out by IG, fear, greed, hope, frustration and boredom are the main drivers in a trader’s performance.


When fearful, investors may keep their impulsivity in check but can also miss out on opportunities.


“One way to limit the effects of fear is by approaching every trade with a plan, and by placing stops to reduce any losses and limits to lock in profits,” experts say.


“If you have carried out sufficient technical and fundamental analysis before you open a position, and if your stop or limit is placed at the correct level, you should be confident in the fact that you have done everything in your power to prevent unnecessary losses.”


Greed, instead, is the impulse to act in irrational ways while seeking excessive gains, pushing traders to act beyond their means.


In this case, it’s important to implement risk management strategies to avoid overexposure to the market.


For instance, the risk-to-reward ratio compares the potential loss to the potential gain for each trade opened. If a GBP300 trade can realise a GBP600 profit, the risk-to-reward ratio would be 1:2, so the potential gain is twice the potential loss.


Hope is often a feeling of expectation and is often linked to optimism, confidence or experience, but when it’s not balanced it can lead to hold onto an investment in the expectation it will turn profitable.


“One way you can prevent hope from impacting your decisions is to set out a number of goals – possibly in a trading log or diary – for your time on the markets. By setting goals, you know exactly what you should be hoping for from your trading, which means that you could be less inclined to let losses run out of frustration,” says IG.


“Equally, a set of goals can help to manage expectations, so you could be more inclined to be happy with what you have earned. This could prevent greed getting the better of you and stop you from opening new trades in the hope of earning more.”


Hope can turn into frustration when the market hasn’t behaved as desired. The only solution is acceptance: every trader will suffer losses at some point, but they can be limited by attaching stops and limits to trades.


These tools will take the decision out of the investors’ hands, preventing them to sell or buy out of frustration or hope.


Finally, boredom is the tendency for traders to get fed up with the financial markets and feel that their routines have become monotonous. It can lead to excessive risk-taking in the pursuit of excitement.


Bored investors could open demo accounts on their platforms, so they can test new methods and learn from mistakes made in a risk-free environment.


If you feel fearful, greedy, hopeful, frustrated and bored, you may have to think twice before hitting the ‘buy’ or ‘sell’ buttons.

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