The difficulty in investment choices emerges when we use a quick and biased approach to stock selection and investing, when a patient, logical, and objective method is required. Quick, impulsive, and prejudiced judgments are the evil of investing, which the current generation of novice investors repeatedly demonstrate.
Many explicable and unexplainable elements impact our investment decision-making, including heredity, experiences from childhood, our own financial situation as we grew up, and so on. When we notice a stock price fluctuation, news about a stock, profits/losses, and so on, we instantly draw conclusions and make biased assumptions. We must intentionally create a slow, logical, and reasonable approach to stock selecting in order to avoid making incorrect decisions.
In this blog post, we’ll look at certain steps on how to achieve this.
Keep an investing journal:
One of the unsolved mysteries of the stock markets is the daily trading of billions of shares, with several individuals purchasing each stock and others selling it to them. The majority of them have the same knowledge; nonetheless, they swap stocks because their perspectives differ. Buyers believe the price is too cheap and will climb, whilst sellers believe the price will fall. So, why do buyers and sellers alike believe that the present pricing of the stock is incorrect?
When we purchase stocks, we tend to be quite confident in our judgment; otherwise, we would not buy. So, one method to lessen the effect of the ‘illusion of competence’ in our investment decisions is to create a brief narrative explaining why we are buying or selling a company – each and every time, in a systematic way, without any exclusions.
For instance, if you are purchasing a stock, try to consider the following pointers:
- Decide your investing time horizon? Be very explicit about this. When short-term investors lose money, they often pretend to be long-term investors. That is attempting to deceive them. This way, if the stock falls sharply after you acquire it, you can tell yourself that it doesn’t matter if you bought for the long term as long as the fundamentals haven’t altered.
- List the reasons why you believe this is an excellent stock to buy.
- What are the risks? Are you prepared to get acquainted with those risks or do you see any able mitigants for those risks?
- How does the market evaluate this stock? Are you more educated than the market about this stock?
- Have the mindset and resilience to face the repercussions of your investing decisions. Don’t worry if it doesn’t work.
At the most basic level, the aforementioned technique has two significant benefits. One benefit is that it slows down your decision-making process, allowing you to avoid making premature investing judgments. Two, frequent use of this produces a positive loop of feedback throughout your investment journey. On a regular basis, say, every quarter, half-yearly, or annually, you should evaluate how your choice to buy or sell a stock has performed. Keeping a journal or a written record allows you to better recall the circumstances in which you formed your investing decision and the reasoning behind it. Based on how the stock has performed, you may determine if your decision was correct or incorrect, and continue to improve your technique suitably.
Furthermore, while analyzing your actions on a regular basis and developing the feedback loop, you must determine if luck had a role in your decision’s success – for example, if you bought a stock in expectation of something happening, but another event caused the stock to rise. Then you must use caution when making further investing decisions for that stock, since this lucky escape may not be repeated in the future. On the other hand, if your investment procedure was solid but an unexpected market occurrence ruined it, resulting in a drop in stock value, there is no need to modify for your investing procedure. Just make sure that the fundamentals of the stock are still intact.
Adopt a disintegrated approach while selecting stocks:
Giving a large weightage to a single measure when making investment decisions is analogous to clutching onto one end of a rope without checking to see if the other end is knotted tightly, cleanly, or at least whether the other end is tied at all or not.
We frequently become fixated on one feature of a stock – whether it is inexpensive, has rapid growth, or the firm has created a fantastic product or service. High-growth stocks may underperform if growth is unprofitable or cash flows are weak; low PE stocks may continue to perform poorly or destroy your wealth, and high-ROE stocks may not provide you with good returns if they already trade at an expensive Price/Book or Price/Earnings ratio.
Many times, it is just a flashy macro tale that drives our financial selections. When investing concepts are offered in verbose writing, even if the arithmetic is unclear, we can be swayed to invest.
Worse, it is sometimes stupid and unreasonable to believe that equities trading in single or double digits (basically, the so called penny stocks) would perform well.
How do we get past the prejudices that affect us in these situations? A fragmented approach to stock selection can help. Under this technique, a stock/company is divided into multiple elements or fragments – such as valuation, growth, balance sheet strength, corporate governance, and so on — and each facet is assessed autonomously to see if one positive component is masking another bad.
This strategy will also help you choose the finest stock in terms of risk-reward in a particular sector. This will provide you with a holistic picture by employing a fragmented technique to observe how stocks perform when the parts are added together before investing.
It is always crucial to discover the underlying variables that generate long-term stock outperformance. This varies by industry, but some typical considerations include value, growth possibilities, current company trends, management quality, balance sheet strength, and so on. Of course, there will be periods when no stock is worth the risk, and in those situations, you ought to stay away from the industry.
Treat your investing decision as though you are injecting a fresh capital:
None of us like to lose. As a result, we may want to sell our portfolio’s wins while holding on to the losers. This bias is known as the ‘Disposition Effect’. However, one important point we miss when we surrender to our biases is that profit or loss is an emotional response that has no influence on how the stock performs in the future. At any one time, the same stock may be enormously profitable in one person’s demat account while losing a significant amount of money in another. So there is no need to sell winnings while hanging on to losers. Furthermore, the ‘sunk-cost fallacy’, in which we tend to average our losses by investing more money when there are far better opportunities available, which confuses matters further.
Overcome these biases by treating your whole portfolio as new money anytime you make important investment choices. Every time you want to sell your winning stocks or commit new capital to lowering the average price of stocks that are losing money, try to ignore the P&L of each stock. You just need to remember that you are beginning from nothing and hence you need to identify the finest ways to invest your cash in order to achieve excellent long-term performance.
This demonstrates a forward-thinking attitude to investing that is not influenced by previous investment decisions (positive or negative). The goal here is to make a move-on from the previous day. Do not try to make up for losses from recent months or years.
However, a key point to remember here is that averaging loss-making equities is not always a terrible thing if the market is mispricing them, and your appraisal of that stock is reasonable.
Final words:
You can implement the three important ideas presented in this article – One is to keep an investment journal and track how your initial theory has performed. The second is to take a fragmented technique when picking equities. It will help you determine if you mispriced the stock or the market mispriced it. Third, see your investments (each and every time) as new money that you are infusing, rather than your portfolio’s current stocks’ profit and loss statements. That is, don’t worry about whether they are winning or losing stocks in your portfolio. These three stages will somewhat aid you throughout your investment path. Happy Investing !!
