Investing should involve research, analytical analysis, and pondered decisions, but oftentimes investors find themselves making rash and impulsive investment decisions that lose them money. So what exactly is behind these decisions, and how can you avoid investing or trading based on impulses?
We’ll review some of the best ways to avoid impulsive investment decisions.
What is an impulsive investment decision?
An impulsive investment decision happens when you invest in something without performing any research or due diligence. Instead of making a decision based on analytical judgment you let your emotions influence the decision.
Investors are affected by different emotions that may drive the way they invest or trade, which may affect their decision process, and the way they conduct their investments. Letting emotions be the sole base for investment decisions can lead to impulsiveness, and this is a common emotional investing mistake.
Why you should avoid making impulsive investment decisions
Making investment decisions based on emotions can, most of the time, lead to steep losses and could affect the long-term returns of your portfolio. For this reason, it is crucial to be aware of your own emotions and how they may be affecting your thinking and reasoning.
Impulsive investment decisions are often based on emotions instead of research, and without the proper analysis and due diligence, you will find yourself making poor trading and investing decisions.
Impulsiveness also leads us to put too much emphasis on the short-term without even considering the long-term risks of our decisions. It also prompts us to ignore the risks or to underestimate them without fully considering our financial goals. For example, this can lead investors to try and time the market without fully knowing what they are doing and how challenging it is.
Investment decisions based on impulse can also lead us to ignore the cost of fees and commissions, which may end up eating our profits.
Letting your emotions drive your decisions will make you impulsive and push you to make mistakes. When it comes to investing, making rash decisions based on emotions and impulses will lead to mistakes and, consequently, losses.
How to avoid investing and trading impulsive decisions
There are several steps you can take to ensure you avoid making impulsive decisions. Here are some of the most important:
1. Always do your research
The only way to make informed investment decisions that meet your criteria and financial goals is by researching and analyzing investments. Without doing it, you will find yourself investing without actually following a strategy, and you could end up choosing investments that do not align with your investor profile and your risk tolerance.
2. Hold yourself accountable
When you make a mistake, you need to hold yourself accountable, which is the only way to improve your investment process. Whenever you make a decision that does not align with your investment strategy, or leads you to a loss, you need to understand what went wrong and how your investment process failed. This will allow you to learn and prevent future mistakes.
3. Use a journal
One of the best ways of keeping your investment process in check is by using an investing or trading journal. This allows you to write down every trade you make and the reasoning or thesis behind it. It makes it easier for you to review and analyze how each trade went in the future.
4. Control your emotions
Keeping your emotions in check can be challenging, primarily when investing or trading. However, remember that in the markets, you need to be as rational as possible and avoid emotion-driven decisions.
5. Learn from your mistakes
Every investor or trader makes mistakes, and it is inevitable, but there are some of them who can learn from it and prevent themselves from making the same mistake multiple times. This is why you need to keep learning and analyzing each of your mistakes so you improve and become better with each investment decision you make.
6. Developing the right trading and investing mindset
Having the right mindset is crucial to be successful in trading or investing. While it may take a while to develop the right mindset, it is undoubtedly one of the critical areas that you should focus on. It will allow you to make your investment process simpler and more organized while also controlling your emotions and impulses.
What to do when you make an impulsive investment decision?
If you have made an impulsive investment decision, you must fix the mistake as soon as possible. This might mean selling a stock you have bought without the proper research or closing a trade that you just got into.
Take some time to understand exactly what drove you to make that decision and what you could have done differently. Most of the time, you will find that the decision was based on emotions like anxiety, greed, fear, or FOMO. Try to identify precisely why you made that decision and how to prevent it from happening again.
Putting in place a set of measures or steps you need to take before an investment decision will also help to hold you accountable during the process. For example, if you determine that you should always write in your journal before committing to a trade, you will be able to analyze and understand the pros and cons of each trade before jumping into it.
Emotions are certainly part of our human nature, and there’s not a single investor or trader that can detach from them completely. What is crucial is to be aware of our flaws and how our emotions can push us into making certain decisions. Hold yourself accountable and create a system and strategy to prevent emotional investing mistakes. If they do happen, make sure you analyze them so that you can avoid them in the future.