Psychololgical Traps
Psychological Traps
1. Anchoring Trap
First, there is the so-called anchoring trap, which refers
to an over-reliance on what one originally thinks. Imagine betting on a boxing
match and choosing the fighter purely by who has thrown the most punches in
their last five fights. You may come out all right by picking the statistically
more-active fighter, but the fighter with the least punches may have won five
bouts by first-round knockouts. Clearly, any metric can become meaningless when
it is taken out of context.
For instance, if you think of a certain company as
successful, you may be too confident that its stocks are a good bet. This
preconception may be totally incorrect in the prevailing situation or at some
point in the future.
Take, for example, electronics retailer Radio Shack. Once a
thriving seller of personal electronics and gadgets in the 1980s and 1990s, the
chain was crushed by online retailers such as Amazon (AMZN). Those trapped in
the perception that Radio Shack was there to stay lost a lot of money as the
company filed for bankruptcy multiple times and shrinking from its heyday size
of 7,300 stores to 70 outlets by the end of 2017.1
In order to avoid this trap, you need to remain flexible in
your thinking and open to new sources of information, while understanding the
reality that any company can be here today and gone tomorrow. Any manager can
disappear too, for that matter.
#2. Sunk Cost Trap
The sunk cost trap is just as dangerous. This is about
psychologically (but not in reality) protecting your previous choices or
decisions — which is often disastrous for your investments. It is truly hard to
take a loss and/or accept that you made the wrong choices or allowed someone
else to make them for you. But if your investment is no good, or sinking fast,
the sooner you get out of it and into something more promising, the better.
If you clung to stocks that you bought in 1999 at the height
of the dot.com boom, you would have had to wait a decade to break even, and
that is for non-technology stocks.2 It's far better not to cling to the sunk
cost and to get into other assets classes that are moving up fast. Emotional
commitment to bad investments just makes things worse.
#3. Confirmation Trap
Similarly, in the confirmation trap, people often seek out
others who have made and are still making, the same mistake. Make sure you get
objective advice from fresh sources, rather than consulting the person who gave
you the bad advice in the first place. If you find yourself saying something
like, "Our stocks have dropped by 30 percent, but it’s surely best just to
hang onto them, isn’t it?" then you are seeking confirmation from some
other unfortunate investor in the same situation. You can comfort each other in
the short run, but it’s just self-delusion.
#4. Blindness Trap
Situational blindness can exacerbate the situation. Even
people who are not specifically seeking confirmation often just shut out the
prevailing market realities in order to do nothing and postpone the evil day
when the losses just have to be confronted.
If you know deep down that there is a problem with your
investments, such as a major scandal at the company or market warnings, but you
read everything online except for the financial headlines, then you are
probably suffering from this blinder effect.
#5. Relativity Trap
The relativity trap is also there waiting to lead you
astray. Everyone has a different psychological make-up, combined with a unique
set of circumstances extending to work, family, career prospects and likely
inheritances. This means that although you need to be aware of what others are
doing and saying, their situation and views are not necessarily relevant
outside their own context.
"I think a lot of people tend to equate their self
worth with their income, or they think that social media, these days puts
pressure on people to make it look like they're doing better than they are. And
because of that, people feel bad," said Amy Morin, Verywell Mind’s editor-in-chief.
"We look at somebody else who has a new car or somebody else whose house
looks beautiful and think, 'Oh, why don't I have that?' And those emotions that
get stirred up, I think for a lot of people are really difficult. Then how do
you decide what you really value in life and what's most important?"
Be aware, but beware too! You must invest for yourself and
only in your own context. Your friends may have both the money and the
risk-friendliness to speculate in pork belly futures (as in the movie Trading
Places), but if you are a modest earning and nervy person, this is not for you.
#6. Irrational Exuberance Trap
When investors start believing that the past equals the
future, they are acting as if there is no uncertainty in the market.
Unfortunately, uncertainty never vanishes.
Read more on
Comments
Post a Comment