When it comes to the pursuit of success in any field, our biggest enemy is most often ourselves.
The biggest threat to our success as investors and traders is not the market, but rather our own psychology.
There are countless psychological pitfalls that can trip us up along the way, but in this post, we’ll focus on the most common ones.
If you can learn to recognize and avoid these psychological mind traps, you’ll be well on your way to achieving your investing and trading goals.
9 Psychological Mind Traps Investors And Traders Get Caught Up in
1. The Sunk Cost Fallacy
The sunk cost fallacy is the tendency to continue investing in a losing proposition in the hopes of recouping our losses.
We often think that since we’ve already invested so much, it would be a waste to give up now.
However, this line of thinking is flawed, because the only relevant question to ask is whether or not the investment still has the potential to be profitable.
If it doesn’t, then we should cut our losses and move on.
2. The Confirmation bias
The confirmation bias is the tendency to seek out information that confirms our preexisting beliefs and ignore information that contradicts them.
This mind trap can lead us to make bad investment decisions, because we’re more likely to invest in companies or industries that we’re familiar with and believe in, without doing proper due diligence.
It’s important to remember that just because we like a company or think its products are great doesn’t mean that its stock is a good investment.
3. The Gambler’s fallacy
The Gambler’s fallacy is the belief that if something happens frequently in the short-term, it will happen less often in the future (or vice versa).
For example, say you’ve flipped a coin 10 times and it has come up heads every time.
You might think that there’s now a higher likelihood of it coming up tails on the next flip, but this is not the case.
Each flip of the coin is an independent event, and has nothing to do with what happened on the previous flips.
This mind trap can lead us to make bad investment decisions when we extrapolate recent trends into the future.
Just because a stock has gone up for the past few months doesn’t mean it will continue to do so.
4. The Availability Heuristic
The availability heuristic is the tendency to base our decisions on information that is readily available to us, rather than on all of the relevant information.
For example, we might be more likely to invest in a company that we’ve heard of before, even if there are better investment opportunities out there that we’re not aware of.
5. The Overconfidence Bias
The overconfidence bias is the tendency to overestimate our abilities and underestimate the risks involved in any given situation. This can happen for any number of reasons, whether that’s because you’ve made some big wins as a paper trader (i.e. in a simulation), or you’ve just happened to be very lucky with your last few bets.
This mind trap can lead us to make impulsive and irrational decisions, because we believe that we’re better investors than we actually are.
It’s important to always stay humble and remember that even the best investors make mistakes from time to time.
6. The Hindsight Bias
The hindsight bias is the tendency to think that we could have predicted an event after it has already happened.
For example, after a stock goes up, we might think that we should have bought it, even if there was no way to know in advance that it would increase in value.
This mind trap can lead us to make poor investment decisions, because we might start chasing hot stocks instead of sticking to our long-term investing strategy.
7. The Herd Mentality
The herd mentality is the tendency to follow the crowd instead of thinking for ourselves.
This mind trap can lead us to make bad investment decisions, because we might buy a stock simply because it’s popular, without doing any research to see if it’s actually a good investment.
8. The Emotional Roller Coaster
The emotional roller coaster is the tendency to let our emotions dictate our investment decisions.
For example, we might sell a stock after it has gone down in value, only to watch it rebound and go up even higher.
Or, we might hold on to a losing stock in the hopes that it will come back and we’ll be able to break even.
This mind trap can be particularly dangerous, because it can cause us to make impulsive decisions that we later regret.
It’s important to stay calm and rational when making investment decisions, and not let our emotions get the best of us.
➜ Related Post: 6 Emotions That Get In The Way Of Your Investing / Trading
9. Analysis Paralysis
Analysis paralysis is the tendency to over-analyze an investment opportunity and never pull the trigger.
For example, we might spend hours researching a stock, but never actually buy it because we’re worried that we’re missing something.
This mind trap can lead us to miss out on good investment opportunities, because we’re too busy second-guessing ourselves.
It’s important to remember that no investment decision is ever perfect, and that we’ll never have all of the information that we want.
Sometimes, the best thing to do is just take a deep breath and go with our gut.
How To Avoid Falling Into These Mind Traps
Now that we’ve gone over some of the most common investing and trading mind traps, how can we avoid falling into them?
The best way is to understand and keep a close eye on the right data. By understanding what information is most important, and tracking it carefully, we can avoid making impulsive decisions based on faulty data.
If you’re unsure of what data to track or how to track it, there are 2 free resources available on our site that you can use to get started:
- The first is our FREE 10 Stock Criteria Checklist, which helps you identify what we consider to be the financially strongest 1% of stocks in the market at any time in less than 5 minutes. Click here to learn more.
- The second is our FREE 90-Minute Online Masterclass, where we’ll show you how we anticipate market crashes in advance and prepare for them. Click here to learn more if you’re interested.
Best,
Terry
