“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”
How surprised would you be to see a headline touting the following?
Down Drops 500 Points Today, Creating GREAT Buying Opportunity!
You don’t ever see that headline. Instead, historically, people tend to pour into the stock market when it peaks and get out of the stock market as it approaches its lows. Traders call this capitulation – when the last scared investors get out of the market, and it usually signals a turn higher in the stock market. Every once in a great while, there is an event which leads to a predictable outcome in the market, such as 9/11 and the opening of the market afterwards, but more often than not, daily fluctuations have no real discernible, tangible drivers, especially when compared to larger, greater macroeconomic trends. Soothsayers in the media try to intuit reasons for every gyration so that you tune in and see the advertisements.
Monkey Brain causes you to make irrational, and wrong, investment decisions. – Click to Tweet
When you pay too much attention, though, you start to question yourself and question your decisions. Wonder creeps in. “Am I too late to catch this bull market?” or “What if the market drops even further?” you ask yourself, and in a moment of irrational exuberance or fear, you make a move.
It’s usually the wrong one. The flow of investor money into the market or out of the market is usually an indication of the opposite happening. Because you tend to remember the last significant effect (losing money, making money), you either are scared of losing again or you overestimate your ability to invest. If you’ve heard of Lake Woebegone, you probably know their belief that everyone is above average. According to research by Cornell University, we all think that we’re better than we actually are because of our own cognitive biases.
Furthermore, because you know intrinsically that making good investment decisions is important, you want to do more research. However, as a study at the University of Pennsylvania shows, when Monkey Brain thinks that a decision is important, he also overestimates the difficulty of making the decision. When we think a decision is difficult, then we tend to overanalyze it. If you’ve heard of the term “analysis paralysis” or fell victim to it, then you know exactly what this feels like.
So, armed with your biases, you listen to Monkey Brain and research, research, research, research, and then act, and often you and act incorrectly.
How do you prevent yourself from falling prey from the tendency to buy high and sell low?
Here are a few things that I recommend:
- Turn off the headlines. Don’t look at CNBC every day. Even the head of the Dow Jones Industrial Average recommends you look at most once a month!
- Value cost average. If you’re committed to a program of periodic investment, then you won’t deviate and you won’t be swayed by short-term fluctuations.
- Make a plan and stick to it. Work from the goal backwards to determine what you need to be saving, sock it away, and keep going.
- Set aside “play” money. If you MUST try to play the market, take a very small amount that won’t affect your long-term goals and go for it. If you happen to invest in the next Apple on the ground floor, then good for you! But don’t count on goosing your retirement with this plan.
Have you had success in keeping Monkey Brain from running your investment strategy? Tell us about it in the comments below!