Mastering Trading Psychology in the Stock Market
By Dale Gillham |
Would it surprise you to know that investors have a strong tendency to sell their losses on a Monday morning? This is according to research just published in the Journal of Behavioral and Experimental Finance.
In this article, we review the findings from the research paper and discuss how you can gain the skills that will enable you to start mastering your trading psychology, so you are able to make more informed decisions.
Why traders sell their losses on a Monday
The research report was compiled by RMIT University Researcher Dr Daniel Richards, who is also a Lecturer in Wealth Management in the School of Accounting, and Dr Gizelle Willows, an Associate Professor from the University of Cape Town
After analyzing 7,200 trading records of retail investors in the UK, they identified the days of the week and the time of day that investors are more likely to trade.
Interestingly, while investors are more inclined to sell their losses on a Monday, they tend to sell stocks that have made gains throughout the week. They also discovered that market returns are generally higher on Fridays than on Mondays, which suggests that investors are consciously or unconsciously influenced more by mood than by stock results.
So why do traders face the anguish of selling loses at market open on Monday’s that crystallizes a paper loss into a real loss?
According to the research paper, investors have time over the weekend to analyse their bad investment decision and, therefore make the tough call on a Monday. Dr Richards states that “considering that Monday mornings and selling losses both have negative connotations, investors choose to combine these two activities and ‘take out the trash’ on Monday, resetting for the week ahead.”
The research paper also found that investors tended to trade more frequently on Mondays than on any other day of the week, and that individual investors were trading in different patterns than institutional investors. According to Dr Willows, “individuals are not only selling more on Mondays, they’re also buying more actively compared to other days of the week. This is different to institutional investors who generally trade less on Mondays.”
Individual investors react to emotional rather than rational decisions
So what is my take on this? Interestingly, the research suggests that there is significant variability between those who are susceptible to biases, such as individual investors and those who are more experienced.
In short, the paper highlights that those who are educated and experienced behave differently to those who lack the knowledge, and as a result those with knowledge achieve better returns, which makes sense. But more importantly, it shows that many believe they have the required knowledge to trade and take profits from the market, when in fact they are more likely to be overly confident rather than knowledgeable.
Having read a number of research papers on behavioural finance, they pretty much boil down to the same conclusions. In short, the masses are being influenced by events, news, and other external factors that cause them to make more emotional rather than rational decisions.
So what can you do to improve the profits you take from the market and, in turn, master your trading psychology?
Learning the skills to mastering your trading psychology
Put simply, it is to get educated. By this, I mean a proper education not some Mickey Mouse information that leads you to be over confident, which the report proves leads to poor decisions.
Reluctance to sell at a loss is one of the biggest sins a trader can make, and results from not wanting to quantify the loss. That’s because in doing so the trader has to admit they made a poor investment decision in the first place, whether it was with their trading rules or something else.
It is important to remember that you cannot and never will control the market. You can only control your decision to enter or exit a trade. And learning to exit is one of the most valuable skills you can develop that will improve your profits.
No doubt, you have heard the saying, cut your losses short and let your profits run. Unfortunately, too many traders do the opposite and then give up altogether believing trading is too hard and/or too risky.
Selling too early just to lock in a profit is one of the major reasons why the majority achieve very poor or mediocre returns. And contrary to what is propagated by a lot of educators, you can go broke taking a profit.
Selling too early when you are in profit is a distinct sign of a lack of education. Indeed, the only reason a trader will sell too early is because they do not know when the right time to sell is.
It is common for the trader to then blame the market or other external factors to justify or validate their poor performance. However, what many traders fail to consider is the real cost of their poor decisions and inaction in getting a solid education in trading, including loss of capital, stress and anxiety, lost opportunity, and the list goes on.
At the end of the day, if you want to trade like a professional and make the money that successful traders make, then you need to do what they do.
No doubt, you have heard that 90 per cent of traders do not make money consistently. That should make it abundantly clear to any logical individual that the only way to be a better trader is to not take any notice of 90 per cent of the things you see, hear or read about trading.
To put it another way, you should only focus your attention on learning what the 10 per cent who consistently make money do.
It is your money and your choice as to which journey you take to become a trader. You can make it as long and hard or as short and easy as you want it to be. That said, being an outlier rather than part of the herd will ensure you achieve your long-term goals in the stock market.
If you are unsure where to start, I encourage you to purchase my latest award winning book, Accelerate Your Wealth - It's Your Money, Your Choice, as it is packed with a number of simple but powerful strategies that will enable you to take control and profitably trade the stock market on a consistent basis.
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