Many individual investors will find it agonizing to talk about China’s stock market bubble in 2007.
I fully appreciate their feelings since many lost as much as 60% of their fortune in the stock market that year. When Shanghai Stock Exchange Composite Index fell from 6000 to 5500 points, almost everyone who lost money still believed in the market’s strength and hoped it would bounce back so that they could recoup all their losses in the near future. Few were willing to withdraw their investments though most knew that “stop losses” is a basic investment principle. Shanghai Stock Exchange Composite Index is struggling against 3000 points these days and the investors who watched their ...view middle of the document...
It seems that the prospects are laid out in a similar fashion to the first ones. However, this time the result is drastically different. 80 percent of the subjects chose prospect 1. The guarantee of gaining $3,000 is more attractive than the probability of gaining more but with risk.
“People hate risk when it threatens gains, but they love risk when it could prevent losses.” Jason Kelly, a bestseller author and investor, summarized.
So now we know why the Chinese investors were reluctant to sell their stocks when the whole market was on a very slippery slope. They were willing to take risks in anticipation of a catalyst that would lead the market back.
Every investor wonders how to become the next Warren Buffet. Some believe that the ability to identify good stocks is the most important. Others consider technical analysis of the market to be the key to success. It seems to me, however, that being able to control your emotions when facing a potential gain or loss is the “Mr. Important” in the competition between you and the market. We all can have think straight when sitting in Starbucks and laughing at others’ bad investments. However, when we are managing our own portfolios, we may fall for the same traps that we laughed at over and over again. What’s wrong with our thoughts when we make our own investments? The answer, for most of us, is we are simply controlled by our emotions.
Don’t underestimate our emotions, since they make us jump to premature conclusions and make hasty moves. There are many kinds of emotions. The main emotion driving most investors is the fear of loss. The next one is “making a quick buck”. However, the one with the most destructive power is greed. Greed can drive an otherwise sensible person crazy. All of these emotions will blind your eyes and cloud your judgment so you can’t see and think rationally. If this happens, no matter how intelligent you are and how good you are at picking stocks or analyzing graphs, the outcome may be a disaster.
Thus, before we start investing, we need to find a way to control our emotions. The technique is really simple: set up investment guidelines and rules. Investors should remain focused and stick to their guidelines even when they lose money. Different investors may have different guidelines. For instance, William O’Neil, the founder of Investor’s Business Daily and a famous investor, has his own “investment law”, such as CAN SLIM. One of his strategies is automation. O’Neil stops his losses at 8 percent of new money placed in a stock and adds more money to winners up to 5 percent above the buy price. If the Chinese investors followed this strategy, they wouldn’t have lost as much.
Bias That We Can Meet in Our Investments
As we mentioned the emotion earlier, a lot of mathematicians and finance experts tried to analysis the historical data in order to find some laws of investment emotion.
After they evaluated the historical data in the last 30 years,...