So you’ve done all your research, selected your stocks and are ready to commit capital? Not so fast! You may want to make sure you are ready to face your greatest enemy — yourself. Here are three common investing mistakes and how you should deal with them.
Getting caught up with the crowd
Groupthink is a classic cognitive bias that extends far beyond the investing world, but it is especially prevalent in our field. It is the reason why bubbles occur, and certain stocks become wildly overvalued. Social media in particular can be a breeding ground for groupthink, particularly if you self-select for a community of investors who all believe the same thing.
By the way, this applies as much to the bears as it does the bulls. As much as we would like to believe that we are all contrarians, this (by definition) cannot be true. So we must put in added effort to make sure that we are not being contrarian just for the sake of it.
Fitting the arguments to the stock
If you find yourself thinking of reasons why your stock is a winner after you’ve already purchased it, then you are probably falling prey to what is known as confirmation bias. This is the tendency to seek out information that supports an already existing viewpoint, particularly one that is of great importance. Remember, your judgement in this situation is clouded, and therefore you should go out of your way to seek out an objective opinion on your investment.
Better yet, find someone who is bearish on your stock. Invite them to rip your thesis to shreds and see if you can defend your point of view with reasoned arguments. If you can sway your fiercest critic, then you are probably onto a winner. If, however, they raise uncomfortable questions, then do not be too proud to concede that you have been mistaken. Too many investors are too concerned with being right, when they should be concerned with making money.
Not learning from your mistakes
No one likes to think about all the times they made a mistake. It is a natural tendency of the human brain to suppress negative memories, or to explain them away in odd ways. For example: “I bought that bad stock because I didn’t sleep well the previous night”. This is known as selective memory, and a lot of the time it can be very useful — after all, who wants to lie awake at night thinking about the social gaffe they committed five years ago? However, in the investing world, where experience is everything, ignoring your poor choices will sink you.
In fact, a lot of individual investors are unsuccessful because they commit the same blunders over and over. They know they shouldn’t buy the latest high-flying tech stock because it has a PE of 50, but they do it anyway. They know that they should be deploying capital when the market sells off 10%, but they can’t bring themselves to pull the trigger. You need to recognise these (and other) tendencies in yourself and act to fix them. There’s no shame in making a mistake. The shame comes from not learning from them.
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Neither Stepan nor The Motley Fool UK have a position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.