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Managing Emotions is Essential to Money Management

Emotions are part of the learning process. Unfortunately, they play a bigger role than we sometimes desire. As with most things in life, dealing with the psychology behind trading becomes part of the process. To create a clear mental image, picture yourself learning to ride a bike. The emotions relative to falling outweighed the logic of balance and speed in the beginning. Through instruction, trial and error, and a few skinned knees we learned how to combine balance with speed to keep from falling. Over time it became second nature to ride the bike. We had to learn how to put our emotions aside in order to ride the bike successfully. What I find interesting about the process is once we learn, the emotions become secondary to the process. They never really leave. They are just subdued by the experience of learning to ride the bike. However, if we hit a bump or try something different the fear will surface again, but this time we have learned to deal with them according to experience. We have all learned the that education plays a vital role in any process. Remember, to keep it simple when starting and then layer on complexity.

Below is a graphic of the emotional cycle relative to investing. It shows the process we go through as investors when we put our money at risk in the stock market. Thus, the term emotional roller coaster. The ups and downs we experience emotionally never seem to change relative to the market cycles. However, we can learn to manage the emotions with a clear understanding of the process. We also learn to deal with the emotions by eliminating false assumptions. We have seen plenty written concerning buy and hold investing. The process made popular during the 80′s and 90′s made the assumption that corrections were temporary and by holding through these correction periods the markets would bounce back in time. However, since 2000 the S&P 500 index has lost money over the ten plus years. Thus, the rebirth of emotions relative to holding investments over the long term. As stated above, education plays an important role in the process. Ask yourself this question on a regular basis, ”If what I always thought to be true wasn’t, when would I want to know about it?’ Continuing education is key to learning how to deal with your emotions relative to the strategy you implement for investing your money. The more risk you subject yourself and your money to, the more emotions you will experience and combat on a regular basis. Choose a strategy that is compatible with your emotional well being.

Fear, hope and greed are the three most common emotions investors deal with. Understanding when they are most likely to attack is the key to dealing with them. The chart above shows fear is most common as the market moves lower and it escalates as the market drops. You can deal with fear by setting stops and establishing a worst case scenario for your money. Greed is most common because the higher the market goes it fosters the belief we will become wealthy overnight. This can be dealt with in the same manner by laddering or trailing your stops to permit your profits to run. But they must take you out of the position should the market turn lower, thus escaping the greed of holding in hopes it will move higher again. This is all part of the process of building and implementing a strategy that fits your personality and accomplishes your goals as an investor.

I have taught a workshop, “Taking the Fear Out of Investing” for more than 20 years and the principles still apply today. The fear factor will step in when you least expect it if you don’t understand the emotion. To quote Edmund Burke, “No passion so effectively robs the mind of all its power of acting and reasoning as fear.” When your money is at risk, fear becomes the greatest enemy to the process of investing. This is where planning becomes vital and takes over versus emotions. When you have a strategy for investing, you have a defined entry point, a defined exit point and a defined target. Why? For exactly this reason, managed emotions to stay off the roller coaster.

This is called a proactive approach to managing your money versus reactive. When the markets move higher you can deal with the, “I am going to miss out on the gain” emotions or greed. When the market is moving lower you can deal with the, “it will bounce I’ll hold until I break even” emotion or fear of loss. The process of managing your emotions is an integral part of money management. Take the time to learn how to manage both and you will be successful.

Disclosure Statement: Jim Farrish is the Founder and Editor of SectorExchange.com and TheETFexchange.com as well as the CEO of Money Strategies, Inc., a Registered Investment Adviser with the SEC. The company and/or its clients may hold positions in the ETFs, mutual funds and/or index funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. Investors who are interested in money management services may visit the Money Strategies, Inc., web site.


Disclosure: no positions