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The Dangers of Emotion in Investing

Here's how to hone in on the 'science' of making money

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Like anything in life, to be successful you need a good strategy.

Something as simple as traveling somewhere you’ve never been before requires a strategy (a map or route on how to get to where you want to go). If you want to lose weight, you need to follow a sound food plan to do so. And if you want to make more money in the market, you should follow a proven, profitable method for picking winning stocks.

Following a proven strategy that works can help you achieve your goals. You’re also more likely to stick with it.

As the saying goes: ‘a good strategy works best when you use it’. And the more you use it, the more confident you’ll become, making you that much more likely to keep using it. And that is the recipe for success, especially in trading.

A good strategy can also help you overcome the biggest obstacle in anything you do – your emotions.

Over-Confidence and Under-Confidence

In trading, being over-confident can be just as destructive as being under-confident. Both can lead to poor decision making.

Over-confidence: Did you know the average investor thinks they’re smarter than the average investor? They tend to attribute their stock gains to smart decisions, while attributing their losses to bad luck.

Unfortunately, the opposite is probably true. The majority of their gains could most likely be attributed to luck, while their losses are more often than not the result of poor decision making.

It’s also easy to confuse skill with a bull market. A lot of bad decisions can get rewarded when the market is going straight up. But, when the cake-walk stops, those bad decisions can ruin your portfolio.

Under-confidence: Constantly second-guessing yourself is no better. Too many investors, after finding a good stock, will try to overcome their feelings of self-doubt by over-researching a stock to find additional reasons to buy. Invariably, they will come across something that causes them to feel even more uncertain, and they’ll talk themselves out of the trade altogether, only to eventually find that the stock had run up as expected, and you’ve missed the whole thing.

Vowing to not let that happen on your next pick, you decide to plunge right in after you’ve found your newest stock. (You don’t want to talk yourself out of it like the last time.) This time, however, the stock drops after you get in, and you immediately regret your decision.

So the next time, you tell yourself you’ll be more diligent, and turn over every stone before your next trade. But, of course, you find yourself back in the same position as the first time, with information overload, and self-doubt, which eventually leads to the same poor result as before.

Being sufficiently confident (not too much and not too little) all boils down to knowing what works, and then doing what works…

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