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How to control emotions when you invest in stock market? 4 best principles to avoid losses in stock market।

          The article informs you about 4 best principles of behavioural finance. It discusses how it will help you when you invest in stock market.

How to control emotions when you invest in stock market? 4 best principles to avoid losses in stock market।

According to report, stock market gave investors more than 16% compounded annual returns within 20 to 25 years. Yet when you ask anyone about this they will say that stock market is risky and they faced huge loss in stock market. Stock market gave a good return but few investors have been able to gain. Most of the time we take our important decision emotionally. Emotions play a great role on our behaviour and decision. Our emotions change continuously. 


How do emotions affect our decisions?


              To answer the question we need a example. Suppose two friends start coaching class. All the things are going right. But one day all students tell one friend(teacher) that his friend(another teacher) can not teach well them. So either he will resign the coaching class or they will leave the class. After somedays his colleague(another teacher) become sick and can't attend the class. So all the students become happy thinking that he is resigned from the coaching class. The other teacher come to know that his friend(another teacher) have brain tumour. When he tells the incident to students they become shocked. Now their anger for the teacher converts into the love for the teacher. They go to hospital and meet with the teacher. They pray for him and request the teacher to join the class as soon as possible. Thus the decision of the students changes fully for their emotions. So we come to know that the action of the students is fully based on the emotions. Similiarly we also take our decision emotionally that is not profitable for us in long term. 


         Now huge information is available for you to analyse any company. Sometimes information is overloaded to you for huge information availability. For this you can't take decisions. Then emotional factors become main to take decisions. There are two benefits if you understand the behaviour of investor. The first is that you can not take decision purely based on emotions. Many times stock's prices fluctuate roughly for the behaviour of investors. So you should understand investor's behaviour. This will help you to find the undervalued stocks in stock market. In stock market you should understand well the two( greed and fear ) emotions. When bull run is continues in stock market or market performs good then most of the investors become greedy. And they buy shares aggressively. They don't analyse the stocks(undervalued or overvalued). When bear run continues or market performs bad then most of investors gets fear and they sell the stocks aggressively.


         Mr. Warren Buffet knows the behaviour of investors. And he uses it to make investment decisions. He says," Be fearful when others are greedy and Be greedy when others are fearful". It means you should become fearful when market is greedy and you should become greedy when market is fearful. And his investment philosophy is based on behavioural finance. Now it is the time to discuss the principles of behavioural finance.


Principles of Behavioural Finance:


•>Sunk Cost Fallacy:

             Sometimes people do the thing that they do not want to do. Such as you go to cinema hall to watch cinema. The film is boring to you but you will watch the full movie thinking that you already gave the full price of ticket. Manytimes students pay the coaching class fees in advance. Though they come to know that the class is not so good and it is waste of time they continues to go the coaching class. They think that when we pay the fees already then it is not right to waste it. But they don't watch that they loss energy,time,transport cost to go to the coaching class. And they go for unproductive thing that can't give any value. Most of the time people don't admit their error after doing mistake. And to justify their wrong decision they continues their mistake. Let's see how sunk cost fallacy works in stock market. 


            When any stock's price is decreasing then many inestors think that they will face loss if they sell the stock. So they buy the stock more and do average. If they see value in the stock and if they have confidence on the stock then it is right. Otherwise if they just do it to justify their past action or wrong decision then it is called sunk cost fallacy. Your investment goal should become to increase your wealth not to justify your wrong decision. Come with next principle.


•> Loss Aversion:

             When we loss in stock market then we are ready to take more risk. It means that to cover the loss we take extra risk. Because the pain of loss is 3 times more than the happiness of profit. In such type of situation investors take decision emotionally. Sometimes this decision may be the reason of his/her financial disaster. The fear of loss makes investors conservative. For this they buy quickly the stock that is already going up. They fear that the stock can be gone in loss. And they hold the loss making stock thinking that the stock will touch its purchasing price. As a result their profit tends to be little and loss tends to be large. We would do the action after taking decision at first and then we think about its result. Rather than it is better to think about result before doing any action. You should think it before that what can be happened in worst cases for any decision? If you can face the worst time then you should make your decision. Thus you can take decision without any emotion.


•> Decision Paralysis:

               When we go to buy shirts to clothing store we like any shirt after observing two or three shirts. But when we see more sample of shirt then it is quite impossible to choose a shirt for more choices. More choices means more difficulty to decide. Such type of situation they do not take any decision. They keep away the decisions for sometime. When you do not take any decision then it is also a decision. The last principle is:


•> Mental Heuristics:

              Our brain always take short cut to process the information. It is called mental heuristics. For this many times investors take decisions(buy or sell) without thinking more. For example investors overreact unnecessarily for the event like spilit that have no effect on the company,industry,economy. 


         So remember the four principles.

1) Sunk Cost Fallacy.

2) Loss Aversion.

3) Decision Paralysis.

4) Mental Heuristics.

These four principles are taken from "Stocks to Riches",written by Parag Parikh. You can read the book to understand the behaviour of investors. 


          If you have any query related to principles and emotions please comment below so that the topic can be covered.


Best wishes to invest.



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