How to avoid this costly ASX investor trap – it's harder than you think

Emotional investing is one of the most common mistakes people make. Here's how to avoid it.

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If you've invested in ASX shares, you've likely struggled with this costly pitfall before.

Investors often buy shares because they have a good feeling about them. And then they hold onto them even when the fundamental reasons behind buying the shares have changed, and the price is falling.

Or, on the other side of the coin, they may sell out of an ASX share simply because they feel it's reached its high.

Investing based on feelings or emotions is something most investors struggle with. But Robert Francis – online trading platform eToro's Australia managing director – says that all too often leads to losing trades.

Check your emotions at the door

"Humans tend to have emotional connections to their money and often subconsciously apply these same emotions to their investment portfolio," Francis told the Motley Fool.

And it's not just newbies putting their hard-earned money where their heart is.

"Even the most experienced investors can fall into the emotional investing trap," Francis said.

That's even more true during periods of higher volatility, which "may incite a feeling of excitement if the market goes up, but can quickly turn to fear if the market crashes". 

The penchant towards emotional investing tends to grow when investors have too much at stake, either in a single share or across the ASX. It's a good reminder only to invest what you can afford to lose. 

And don't let yourself get a big head if you've made some profitable investments.

According to Francis:

Another pitfall for investors is overconfidence. After making a few rewarding investments, investors can delude themselves into thinking they're above the average investor in a bull market and tend to trust their gut with everything. This often leads to loss. 

Stay humble and, remember, you're never too old to learn. "Some of the most successful investors are also the most pragmatic," Francis said.

Fear and greed on the ASX

Francis calls emotional investing, as opposed to investing based on logic, a high-risk method. "Often it will lead investors to make irrational decisions based on short-term fear, which causes them to lose sight of their strategic objectives and financial goals."

So what types of mistakes can emotional investing lead to on the ASX?

According to Francis:

The most common emotional reaction is that investors either experience buyers' regret or overreact during times of stress, euphoria or panic. It means they're more susceptible to hype-buying, which can lead to ill-informed investment decisions.

It can also lead to panic-selling where potential profit is not realised because the stock is sold at a loss, or significantly lower than its intrinsic value.

As for investors who may have sold most or all of their ASX shares during last year's COVID driven market rout and are still sitting predominantly in cash, Francis said, "Investors driven by fear or pessimism can miss out on investing opportunities waiting for a market correction or bear run that doesn't come."

Indeed, investors who've been waiting for a market correction following the 2020 February and March selloff are most likely still waiting.

Down a slender 0.11% at the time of writing, the S&P/ASX 200 Index (ASX: XJO) is up some 49% since the 20 March 2020 lows.

How can ASX investors avoid such a common human impulse?

The big question for ASX investors then is: how can we avoid such an integral human impulse as emotion?

According to Francis, "The key is to take a rational, measured approach to investing. This mindset can be achieved with due diligence, a disciplined investment process, and a sense of perspective."

Francis shared a few other tips with the Motley Fool.

Chief among those is to "establish and stick to a strategy" with clear investment goals. Taking a long-term view tends to be an easier plan to stick with and "prevents investors from getting caught up in short-term traps".

Another investment nugget he shared: ignore the hype. Now, this isn't always easy to do. Particularly in today's world of around the clock news feeds accessible almost everywhere you go.

But Francis urges investors to be critical of the information they come across. "Research your investments before deploying any capital. And make informed decisions about the intrinsic value of a company before you introduce it to your portfolio."

Two other valuable, but often overlooked, investing tips Francis shared to help manage risk are: diversification (stocks, crypto assets and other financial instruments) and dollar-cost averaging (DCA).

Finally, Francis told us, it's best for investors to just be patient.

Many investors already know the saying 'investing is a marathon, not a sprint'. But really, this is true. The more investors try to get rich quickly, the greater the chance they will lose their money. Usually, the sprinter is emotional.

Being consistent over time is extremely difficult. However, being an emotionally controlled marathoner will generate consistent and long-term returns.

There you have it.

ASX investors, you'd do well to check your emotions at the door.

Motley Fool contributor Bernd Struben has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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