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posted on 27 January 2017

Are Emotions Inviting You To Buy Or Sell Stocks?

by Sam Seiden, Online Trading Academy

Online Trading Academy Article of the Week

Investing psychology is a subject most books and so called professionals keep separate from the mechanics and strategies of proper investing. A reality largely misunderstood is that the underlying mechanics and strategies within proper investing are a direct function of your psychological belief system.

At any given time in the stock market, there are buy and sell invitations sent out in the form of news events, technical indicators, earnings reports, company announcements, brokerage upgrades and downgrades and much more. These invitations are then received by the belief systems of many millions of investors worldwide. Traders without proper understanding of investing psychology fall victim to their emotions, making poor trading decisions.

What separates the consistently profitable market player from everyone else is a psychological belief system that filters all these invitations to buy and sell through the markets ongoing supply and demand relationship. When this is done properly, you will quickly realize, for example, that often a buy recommendation from a brokerage firm and/or a good earnings report from a company do not equate to paying wholesale prices for the stock at market demand, or higher prices for the company’s stock in the near future. Conversely, negative news or a brokerage downgrade may actually be a low risk / high reward buying opportunity.

Some of the most common and popular invitations to buy and sell occur with stocks. Providing awareness of the various buy and sell invitations for stocks, demonstrating how to mechanically filter these invitations through the stock market’s true supply and demand and providing rule based tools for taking advantage of these frequent red flags and opportunities is the focus of this article.

Understanding Investing Psychology Leads to Consistent Profitability

Someone who understands investing psychology knows that a psychological belief system that enjoys consistent low risk / high reward profits is one that identifies and accepts an invitation to buy into a market when objectively, market price is at a level where demand greatly exceeds supply. In contrast, a belief system that suffers consistently poor results is one that identifies and accepts an invitation to buy into a market when objectively, price is at a level where supply exceeds demand.

There are two types of buy and sell invitations.

1) The markets buy and sell invitations which are based only on the irrefutable governing dynamics of supply and demand.

2) Everything from good and bad news to positive and negative earnings reports to brokerage upgrades and downgrades and many more.

The first has you focus on reality, while the second has you focus on everything but reality. Banks and financial institutions understand this, which is why they consistently profit and achieve financial goals and the average investor doesn’t.

For example, most people buy a stock when that company has good earnings, a strong management team, healthy balance sheet and the trend of the stock is up. What they don’t realize is when all these things are “good", the price of the stock is almost always high, at or near retail prices where the smart money is selling.

Why would an investor make such an obvious mistake and buy when price is up? Simple, the belief system that drives their behavior/action is flawed. When you understand that your psychological belief system IS your investing strategy, you will realize how important it is to align your belief system with reality. You are essentially searching for truth so beware of illusion. The addition of even the slightest amount of illusion into your belief system ensures truth will never be found.

Often, the focus of poor investing results is placed on a lack of discipline when attempting to follow the rules of a strategy. What keeps people from following their trading rules is not a lack of discipline; it is because their response to invitations to buy and sell are not in-line with their psychological belief system. There is internal conflict when it is time to take action. Don’t punish yourself for not acting when the market calls you to action. Instead, spend some time reflecting on your investing psychology; take a step out of the box that is your belief system and make sure it is only filled with objective information and reality.

Investing Psychology Opposes Natural Tendency

All the news and market information is filtered through your belief system. Your belief system is responsible for the thoughts and perceptions created from the news and information. Every thought and perception leads to ACTION, which when investing is either buying or selling. Therefore, all the consistently profitable investor needs to focus on is price. Whatever the news and information for the stock is, your belief system MUST filter that information through a filter that quantifies the market’s TRUE supply and demand relationship before a perception is created and action is taken. This will ensure you will not fall into the trap that has buyers pay too high of a price for stocks. It will allow you to profit from the many others that consistently do fall into this trap. Note: Wall Street knows this and profits greatly from it.

The natural tendency to buy in the stock market is completely inversely related to how you make money buying and selling anything. It is certainly not in alignment with supply and demand.

Most people are not naturally inclined to buy when the objective low risk / high reward buying opportunity is in front of their face. For example, PRICE MUST DECLINE in order for it to reach an objective demand level (wholesale prices). The vast majority of people are only comfortable buying after a period of rising prices, not declining prices. Also, most people are not comfortable buying when the news is bad. The challenge to your natural human emotion is the fact that a healthy uptrend and good news rarely if ever brings price down to price levels where demand exceeds supply.

This is all quite ironic if you think about it because if you take your average investor out of the market environment, they act almost opposite when buying and selling anything else. For example, when we go and buy a car, we try and get the best deal we can. The astute car shopper finds a car and knows what price he or she is willing to pay and attempts to get that price. If that dealership is not willing to drop the price to the desired price of the buyer, that potential buyer typically goes from dealership to dealership to find someone willing to sell the car at the lower price.

When investing however, people for some reason wait for good news and higher prices before deciding to buy. This makes absolutely no logical sense if your goal is to buy low and sell at a higher price. It is completely inversely related to how we profit when buying and selling anything. This, again, is why Wall Street almost always achieves record breaking profits and the average investor hardly ever comes close to achieving their financial goals. This, in turn, is what keeps people from living a life they want to live.

Whether you invest in stocks, bonds, futures, currencies, options or anything else, how you profit in these markets and how you quantify supply and demand never changes. Furthermore, a proper investing strategy that works is one that is not market specific or time period specific. The strategy that offers consistent low risk returns is one that employs a correct understanding of investing psychology and mechanically filters the vast amount of illusion creating information by objectively quantifying supply and demand in any market and at any period in time. Don’t let the shadow of illusion darken the reality of a governing dynamic that is always right in front of you.

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