Why do we sell low and buy high?

We’re often told that in order to be a successful investor we need to buy stock at a low price and sell it at a higher price. If we do that multiple times, we are destined to be rich. Why is it then that so many of us do the exact opposite?

My intention in this article is to have us open our minds and address some key questions we seldom ask ourselves. Reflect upon your answers and consider what they reveal about you as an investor.

Which of the following sentences applied to you a few minutes or days before you purchased a stock or shares of a mutual fund?

·         I read a great story about the company that said now was the time to act.

·         My friend told me she made a 100 percent return on a stock, and I asked myself, “Why her?”

·         The markets are breaking new highs every other day, and I felt left out.

·         I read yet another story about the urgent need to plan for retirement.

·         I learned through a seminar that the only way to make money these days is   through the stock market

Which of the following sentences applied to you a few minutes or days before you sold a stock or shares of a mutual fund?

·         I read in the paper today that the economy is going to tank, oil prices are going to skyrocket, and consumers will have no money left.

·         My friend told me that he now sits on the fence after making a lot of money selling his stocks.

·         My stock just dropped another 5 percent on top of the 20 percent it had already lost.

·         I read yet another story about the urgent need to plan for retirement.

·         I learned through a seminar that the only way to make money these days is to buy gold/silver, purchase a vacation house/second condo, or collect art.

Do any of the above sound familiar? How many times have you asked yourself, “Why did I buy this stock in the first place?” or “Why can’t I make money like Joe?”

As humans, we are driven by several psychological factors that may explain why we aren’t making the right decisions when it comes to buying and selling stocks. I’ll discuss two of them in this article.

The first factor—the fear of losing (or losing too much)

Let’s say you had to choose between the following two alternatives: a sure gain of $240 and a 25 percent chance of gaining $1,000 with a 75 percent chance of gaining $0. Which one would you choose?

According to statistics, you should choose the second option, in which you would have gained $250.

Now consider these two alternatives: a sure loss of $240 and a 25 percent chance of losing $1,000 with a 75 percent chance of losing $0. Which one would you choose?

According to statistics, you should choose the first option—a sure loss of $240.

Which option did you choose?

Studies show that people feel the pain of loss twice as much as they feel pleasure from an equal gain. Consider your point of view; would you gain more pleasure from winning $100 or suffer more agony from losing $100? What if the figure were $10,000?

Most investors tend to sell an investment prematurely because they cannot bear to “suffer” any longer. How many times has this happened to you? Even worse, how many times have you sold a stock only to see it rise immediately after? In those cases it is important to keep in mind that the stock doesn’t know you. It isn’t rising just to upset you. It’s all in your head.

So what can be done about this? How about familiarizing yourself with the value of a company before you purchase its stock? How about knowing the sell price before you buy?

The second factor—the need to be liked and our urgency society

We are conditioned as children to believe that we are who our friends are. We develop personality traits similar to those of our friends and tend to act in ways that we believe will get people to like us and want to be around us. After all, don’t we all want to be popular? Who wants to be the kid standing all alone on the playground?

As we get older, we are conditioned to buy into society’s urgency mentality. How do you feel when the phone rings? Do you feel a pressing urge to answer it? The media contributes largely to this mentality by using words like “now,” “last chance,” and “don’t miss the bus.”

These two psychological factors greatly affect our investment abilities. When our friends share their investment successes, we want to be on their winning team. When we’re told, “Be sure not to miss the party,” we immediately feel the need to join the party. (Wouldn’t it be great to stand around at the Friday party with all your friends and tell stories about your stock market successes?) All of this causes us to believe that the only way to join the party is to do what your friends are doing, in this case buying and selling stocks.

As investors we feel more comfortable with the knowledge that our friends and peers own the same stock as we do. It’s interesting to consider that we feel better knowing that if we lose money on a specific stock, we won’t be the only ones.

So what can you do about this? There is a third option: deciding not to buy a stock is also a choice that we can act upon. Regarding the need to feel liked, take a moment to consider your end goal. Is your goal in investing to make friends or to create wealth?

Excerpted from “Why do we sell low and buy high? The guide you must read BEFORE you invest" by Amir Avitzur Copyright © 2012 by Amir Avitzur.

 More information about the book can be found on Amazon.com or at www.AmirAvitzur.com