Understanding Investor Psychology

Investing, whether it be in stocks, cryptocurrency, bonds, or anything else, is very quickly becoming one of the most effective ways to build wealth in the modern world. However, the element of chance has quite a significant effect on the outcome of investing, and risk is always going to play a big part.

Due to these two factors, whether an individual’s single investment is successful or not is often beyond their control. That being said, when we look at investing in the long term, it is actually the investor, their psychology and behaviour, that has the most influence on long-term results. In this article, we take a deep dive into investor psychology, understanding how it often dictates the outcome of investments.

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The Role of Risk

Every investor will have heard the old adage to ‘never invest more than you can afford to lose’; the reason for this comes from the high level of risk involved in investing. This risk stems from the fact that investments are speculative, meaning their value can change rapidly due to a variety of different factors.

The simplest way to understand how risk operates in investing is to take a look at its role within the online casino world. Readers can compare Australian operators, or any other online operators in thriving markets like the US and Europe, to get a better grasp on the role of risk and chance in this industry. Gambling is so associated with risk and chance that even one of its definitions is to ‘take risky actions in the hope of a desired result.’ In gambling, there are various factors that can influence the chance of a win, such as paylines, return-to-player score, bonuses and rewards, and, in some games, skill, but at the end of the day, it is chance that determines the success of every play.

Similarly, the success of any given investment has various aspects that influence it. Instead of things like RTP score and paylines, investors need to be aware of market conditions, public sentiment and taxes. Yet, when all is said and done, it is chance that has the final word. So, investing itself is just another form of gambling.

The Fear of Regret

One of the biggest psychological influences on whether or not an investor is rewarded for their investments is something called fear of regret. In simple terms, this fear of regret refers to investors avoiding selling assets that they made a mistake in purchasing.

The idea here is that the embarrassment of making the investment in the first place, at a price that they do not believe was worth it, puts them off ever selling the asset on. This then leads them to hold on to losing investments, which will continue to drop in value, causing further losses.

To avoid this, investors should not let regret over a bad investment dictate their logical decisions. Everyone makes mistakes, and the best thing to do when you see that an investment is losing is to sell it and move on as quickly as possible.

The Overconfidence of Investors

We all like to think that we are good at what we do. If we thought we weren’t, we probably wouldn’t keep doing it. However, a lot of the time, patience and a little bit of humility are often the best assets you can have when engaging with an activity, and investing is no different.

Overconfident investors will operate under the assumption that they can consistently time the market. However, countless studies and evidence have suggested that this is simply not possible for a human mind to do. As such, overconfident traders often make the mistake of excessive trading, which will lead to trading costs denting profits.

Investors are encouraged to utilise market analysis and artificial intelligence tools to observe the market and provide them with real-time updates, but we must still remember that these tools cannot operate with one hundred per cent accuracy.

Prospect Theory and Loss Aversion

This is a strange psychological observation that reveals that humans tend to have a stronger emotional reaction to a loss than to a gain. A loss makes us more stressed, distressed and frustrated than a gain makes us happy.

This has real, observable effects in the investing world. For one, it reveals why investors have a tendency to hold on to losing stocks, as we are more likely to take unwise risks to avoid a loss than to realise a gain. Again, we can compare this to gambling behaviour seen when gamblers chase their losses and double up on bets rather than accepting a negative reality.

Investors and gamblers alike should cut their losses. For gamblers, that means walking away from the game, but for investors, it means actively selling losing investments and having the emotional maturity to accept their loss, rather than holding on to it and making it worse.

Anchoring Behaviours

This is the tendency many investors have to put too much faith in the market price and fully believe that it is the ‘correct’ price. They will take things like public opinion, events, and recent market reviews as gospel and allow them to dictate every aspect of their investing behaviour.

Instead, investors need to realise that recent trends do not have as much influence on the market as historical, long-term averages and probabilities. Successful investing is about playing the long game, not being carried away by sudden market fluctuations.

When investors make decisions in bull markets, they are often influenced by price anchors. These are prices that are deemed significant because of how close they are to recent prices. However, to be successful, investors should take into account the more distant returns of the past before allowing price anchors to dictate their investments.