“When one door closes, another one opens; but we so often, for so long and with such regret we look at the closed door, that we do not see those, that open up for us ”. – Alexander Graham Bell
Successful investors and traders know the pain of regret. They looked at the closed door, probably repenting, what did not buy Dell in 1993 or what was not sold short NASDAQ in April 2000.
Regret – psychological pain, which comes, when you understand, that you made a bad decision, when it was possible to do everything differently. Emotionally savvy investors know, that you shouldn't look at a closed door for too long, to learn from mistakes.
Revealing, understanding and managing regret – here is the basis of that, to become an emotionally literate investor. Emotional literacy includes four abilities:
1. Recognizing emotions in yourself and others.
2. Directing emotions in the right direction for reflection and problem solving.
3. Understanding, how emotions combine and change over time.
4. Managing emotions to achieve goals.
Profit from pain
Investors can develop these abilities, to increase profits and increase pleasure, what they experience from investing. To understand, how successful investors can use these four abilities, consider Lisa's difficult situation, struggling to survive in the investment world:
When Lisa bought shares at 30 000 $, she expected to make a significant profit. Lisa so hoped for success and was so confident, that I bought these shares with all my money. Stocks began to fall shortly after the purchase.. Her position is now worth approximately half of the original price.. Lisa's hope and optimism turned into regret and pain.
Knowing my regret, Lisa has already demonstrated the first of four emotional literacy abilities.: the ability to recognize emotions in yourself and others. She also demonstrated a third emotional literacy ability., ability to see, how emotions change over time. Lisa knows, how her hope and optimism turned into pain and regret as, how she saw the value of her investments fall.
Emotionally savvy investors take advantage of the joy, and pain to your advantage, remembering how you felt about past successes and mistakes when making future decisions. When Lisa will make decisions in the future, she will definitely remember her current feeling of annoyance. Emotionally savvy investors deliberately evoke past feelings of joy and pain, which remind them of using effective investing and strategies for managing emotions. There are many different strategies, which Lisa could use, to manage regret. These strategies are based on scientific developments in the field of behavioral finance., изучающих, how social and emotional factors influence economic decisions.
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Research shows, that pain and regret, experienced by the investor in case of loss of this amount, turn out to be a much more intense feeling, than the joy of making the same amount of profit. In this way, it is worth protecting yourself from losses.
Fundamental Principle trading “Limit your losses and let your profits grow” is an integral part of many investment and risk management models. For example, William O'Neil, founder of Investors Business Daily, advises investors to get out of losing positions, when they fall more, than on 8-10 % lower purchase price. Lisa's investment must now double its current price just to, to break even. To avoid future regrets, she could cut losses by 10 %, проиграв 3 000 $, but not 15 000 $.
Pyramiding positions
Behavioral finance researchers have discovered, what investors, who buy fund units in their pension accounts, using the average dollar price (buying in addition after some time for the same amount), feel less regret, than investors, who make spontaneous purchases. Likewise, investors, who buy or sell their positions right away, instead of, to gradually change their size, blame themselves more often and feel regret. To minimize the likelihood of being annoyed, it is worth increasing the position size, if the market is moving in a profitable direction.
Like cutting off losses, pyramiding positions also helps to manage risk. If Lisa split her position and took a 10% stop loss, she would have been knocked out in the foot even before, how would she manage to invest all her capital, сэкономив, thus, even more money, than if she made a one-time purchase.
Partial profit taking
Position resizing – partial profit taking, as soon as the price approaches the first target – is another way to minimize regret. Taking even a small amount of profit increases the likelihood of making a profit on the entire position, even if she turns around. Use trailing stops for all or part of your position – adjust stops to the current price as, how she moves in a profitable direction – this is another way to reduce regret and improve the likelihood of taking profit.
Beware of bias
Одна из причин того, that people tend to feel sorry, is, what do they view the events of the past, as more obvious, what they really were. Behavioral finance researchers refer to this phenomenon as “bias propensity”. Market bubbles are obvious only after the fact, оглядываясь назад. For example, easy to spot with a biased eye, what in 2000 year, shares of Internet companies were highly overvalued.
One way to control bias and regret is, to learn to forgive yourself, realizing, that no investor has a magic crystal ball. Emotionally savvy investors go to great lengths to make difficult financial decisions with limited information, forgiving myself, если окажутся неправы.
Don't be overcautious about emotions.
Sometimes investors avoid making decisions for fear of feeling regret, если окажутся неправы. This is especially true, when given a second chance to buy at a higher price, even when the trade still appears to be profitable. Consider the following scenario:
James had the opportunity to buy shares in a small biotech company, but decided not to do it, because I was not sure about the company's new drug. One year later, after careful analysis of the company, James decided, that the drug is very promising, but by this time the price of shares on the stock exchange had doubled. Although the company now looked even more promising, than ever, James couldn't bring himself to pay twice as much., than was possible a year earlier.
James's reluctance to buy a fledgling biotech company just because, that she doubled in value, demonstrates to us, how some investors reject good investments, because they expect to feel regret, if they overpay for them. В действительности же, investors underestimate their own ability to cope with disturbing emotions, including regret. At the same time, they show completely unnecessary reinsurance due to emotions.. If the deal looks attractive, совершите ее. You can always pyramid and cut losses to reduce regret., если цена пойдет не в вашу сторону.
Take responsibility
One of the reasons, by which people trust "experts" to manage their money, is that, that this way they will feel less regret, if things go wrong, how to – always will be, who to blame. Actually, some behavioral finance researchers suggest, that one of the reasons, that financial institutions employ external wealth managers instead of, to manage money yourself, is, that these institutions are insured in advance, that was, who to blame, if their funds work poorly. Considering, that most outside managers fall short of relevant market benchmarks, such institutions pay a steep price for using outside managers, just for the sake of it, to avoid regret.
Investors, managing your own money, некого обвинять, except ourselves, when things go wrong. Это особенно верно для тех, who counts, that the best return on investment is obtained, when trades are made against the generally accepted trend. To go against the crowd, you need to have fortitude, accepting guilt and regret, when ideas turn out to be wrong.
Be yourself
When you make investment decisions, непохожие на те, what do you usually do, and things went bad, You can expect regret. The more unconventional the solution was, the stronger the feeling of annoyance.
Newbie Investors, who in the past have entrusted the management of their portfolio to investment advisors, especially vulnerable to regret, when they start making their own decisions, because we are used to, that someone else is managing their money. They should be prepared for some setbacks and forgive themselves., when something goes wrong, как запланировано. Taking ownership of the investment gradually can also help overcome regret.. If the first investment of a newcomer turned out to be significant in volume, but poor in execution, he runs the risk of experiencing so much regret, that will undermine faith in yourself for a long time.
Do not strive for sinlessness
Investors, who have set themselves the goal of obtaining stable, but not outstanding profits, less likely to feel regret, than those, who strive for excellence. Emotionally savvy investors know, that not every trade will be a winning one. As markets reflect the collective actions of people – erroneous by nature – the markets themselves are also imperfect. In this way, striving for consistency, not perfection, you can reduce regret and improve investor satisfaction with their work.
Open the door to success
Although regret – painful emotion, it offers investors the opportunity to learn something every time. Successful investors learn to recall past regrets and use effective emotion management strategies. Emotionally savvy investors don't dwell on their regret. Instead, they look at the markets, as new opportunities for success. Like Alexander Graham Bell, emotionally savvy investors are aware, what, когда одна дверь закрывается, another one opens.
Eliot Brenner, Ph.D.
© SFO Magazine, February 2007
