Effective investing in the stock market is based largely on the analysis and appropriate selection of financial instruments that will bring profit to the investor, although the risk of loss should also be taken into account. An equally important element of investment success is the skillful management of the asset portfolio, which is not possible if we can not manage our own emotions. So how do you invest in the stock market so you do not get carried away by emotions?
Pay attention to the objective market measures
Greed and fear are two basic emotions that govern the stock market. Unfortunately, standard economic models do not include them. What’s more, they do not take into account the fact that economic decisions made by investors do not have to be rational. Even if historically high rates of return tempt us with promises of achieving above-average profits, it is worth limiting greed.
In this respect, it may be helpful to analyze the objective measures of the market, in particular the valuation indicators. They include, among others, an indicator showing the relation of the share price to the profit that falls on it. The golden rule of investing warns us against excessive optimism. High valuation ratios should therefore be of our caution. They mean that the shares of a given company are simply expensive.
Of course, such an interpretation is a great simplification. It does not pay attention to the reasons why the index has reached such and not another value. A high share price to profit ratio may mean that investors expect to achieve an even higher return on investment in the future. Nevertheless, as mentioned, high valuation ratios should cool our expectations.
Analyze sentiment indicators
Worth noting are also various sentiment indicators. They set the level of optimism among stock investors. If their values approach the level referred to as extreme optimism, one can assume that the market is already largely bought.
Conversely, the sale of the market signals the value of the indicator approaching the level of extreme pessimism. Thanks to the analysis of sentiment indicators, we will not make the basic error that greed and fear force us, that is, the purchase of shares at the very top of the bull market and their sale in the stock market hole.
Do not fall into the trap of fear and partly pass your position
The investor’s decisions are particularly adversely affected by the bear market. From day to day, market sentiment deteriorates, and advancing declines cause investors to panic. It is talked about the collapse of the financial system and counts down the bankruptcy of the state, which further aggravates the difficult situation of investors.
In addition, there is usually a lack of willingness on the part of the investor to implement the loss, as a result of which the position is held for too long, which is associated with further losses. The exit from the impasse is a partial liquidation of the position, which allows you to regain mental comfort. In this way, in conditions of strong stress in the market, the investor is able to return to the cold calculation of events.
Act according to plan
In order to avoid emotions dominating over rational analysis when making investment decisions, it is worth acting based on a well-thought-out strategy. Already at the beginning of our investment route, when we set up a brokerage account, it is worth knowing what level of risk and how high the loss, we are able to accept if the prices of financial instruments begin to fall.
Similar predictions are worth describing in relation to the profit that satisfies us. This will help us to keep common sense and not succumb to greed in a situation where bull market and excessive optimism of investors prevail.