Emotional investing can be especially common in volatile markets such as cryptocurrencies. Emotions such as greed and fear can easily cause otherwise rational investors to act in irrational ways.
What’s more, collective sentiments can have very real effects on a market. Once a certain sentiment gets hold of a market like crypto, it can be all too easy to get caught up in the hype. And when you get caught in the hype, it becomes all too easy to become totally irrational.
If you’re new to investing, you might be in an especially dangerous position when it comes to handling your emotions. Below are a few tips to avoid getting swept up by market sentiment and help you succeed in the long term.
1.) Never Go All-in
Let’s say you’re familiar with mainstream cryptocurrencies and want to start trading in private coins like Monero (XMR). You probably don’t want to put everything you have in your Monero wallet—at least, not yet. Diving into an unfamiliar coin based on a “good feeling” is probably not a good idea. Even seemingly similar cryptocurrencies like Bitcoin and Monero have markets that act differently, as the two coins appeal to different types of investors and users.
Instead, you probably want to get into a cryptocurrency by familiarizing yourself with all of its unique features and only trading small amounts for a few months. After some time, you should gain a much better appreciation for the market’s specific quirks and behaviors. This should allow you to better reduce your risk exposure and, perhaps, help you understand your instincts better.
2.) Understand that Markets are Irrational
If you’re serious about investing, you will probably have encountered several ways to model market behavior. The strange thing about many widely used market models is that they often assume that market actors are either completely rational or act irrationally in completely predictable ways.
Of course, humans and, by extension, the markets they participate in are not totally rational. While models, theories, and historical explanations are very useful, it is important to understand them in the context of imperfect human behavior.
3.) Learn about the Recency Bias
Investors are prone to all kinds of biases, but the recency bias is perhaps one of the most powerful. The recency bias is a behavior anomaly where humans assume that the recent past will be very similar to the near future. It is related to the better-known gambler’s fallacy and hot hand fallacy. In both these fallacies, there are wrong assumptions of probability based on previous events.
The recency bias is why investors can often feel that every market dip is an oncoming crash and every uptick will take their investment to the moon, so to speak. By understanding the natural human tendency to give in to the recency bias, you can not only avoid getting caught up in the hype, but you can also learn to see its effects in different market movements.
3.) Know When to Stay the Course
Understanding the recency bias should also give you a better idea of when to stay the course. This is especially important for volatile markets where the constant short-term movements may often obscure the market’s long-term direction. Knowing when to stay the course is important, as surviving short-term setbacks is often key to lasting success in most markets.
If it’s not time to stay the course, it’s a good idea to have a backup plan in mind. Choose some dependable low-risk securities to move your funds to for when you need to let your riskier investments go.
4.) Implement Proven Long-Term Investment Strategies
In the vast majority of cases, investors are generally better rewarded for their time in the market rather than for timing the market. If you’re into trading and investments for the long haul and fully understand the benefits of compounding wealth, you may be far less likely to give in to emotional investing.
Among the most popular long-term investment strategies are diversification and dollar-cost averaging (i.e. investing fixed cash amounts regularly, regardless of the market price). Faithfully implementing these and other long-term investment strategies can ensure that you consistently make logically-driven decisions, which may influence your investment style to become more data-driven and logical.
5.) Recognize Myopic Loss Aversion
Myopic loss aversion is a term used by behavioral economists to describe the irrational sensitivity people have to losses. It is closely related to the endowment effect, where investors place a higher value on something that they own than the same item owned by someone else.
Both myopic loss aversion and the endowment effect are often used to explain why low price sell-offs are commonplace during dips in the market and why some investors may buy high when sentiments are positive. Myopic loss aversion is also characterized by frequently checking portfolios, news, and digital wallets for fear of losses.
Avoiding the effects of myopic loss aversion can be tough, especially if you have not diversified your portfolio or have failed to recognize the effects of your emotions on your decision-making. Take the time to learn a more holistic view of trading so that you may learn to avoid falling into this emotional trap.
6.) Take Care of Your Mental Health
It has to be said that our ability to understand and resist emotional decisions has much to do with our mental health. Being constantly anxious or stressed is not going to do any favors for your ability to make rational investments. By taking the time to become mentally and emotionally healthy, you can lay the foundations for wiser investments and more sustainable wealth-building.
Can You Invest Without Emotion?
Given our human urges and instincts, investing without any emotion whatsoever may be too much to ask. However, there is still much that you could do to keep yourself calm when the markets get dicey. By understanding your tolerance for risk, natural emotional states, and the common biases rookie traders fall into, you’ll be better equipped to weather the most volatile markets and achieve long-term investment success.