A new study confirms what I have long suspect might be the reason for many people.
Maybe you’re just trying too hard!
Or, as one of my favorite market writers Martin Pring says: The stock market is designed to exploit your character flaws.
Here’s what I’m talking about.
A recent study* found that in gambling, both winning streaks and losing streaks really do exist and persist in time. But not because of any help from luck, or whatever talisman you might believe in.
Instead, it’s because gamblers’ recent experiences in gambling (and also in the stock markets I’d guess) affect their behavior.
Winners, either because they want to protect their winnings or because they expect to lose following a victory, tend to become more wary and place more cautious bets. With the odds more in their favor on such cautious bets, they are more likely to win. So they do, even if the returns are lower on these more cautious bets.
In contrast, losers tend to place riskier bets, either because they think their luck “has to change” or because they feel pressure to “make it back.” So they take on more risk. Thus they are more likely to lose. In other words, the house is exploiting their character flaw of feeling desperate to “make it back” after a loss.
I suspect the same process is at work in the stock market. After experiencing a heavy loss, a lot of investors probably take riskier bets because feel desperate to “make it back.” Of course, the market is all too happy to take advantage of this state of mind to liberate them of more funds.
Or as I like to say: “The trade isn’t over, until you are emotionally neutral about it.” The reason is obvious: If you are not emotionally flat about your last trade, whether it was a winner or loser, it will affect your judgment. I know that is certainly the case with me, and its why I constantly monitor myself to avoid falling into this trap. It might pay for you to do the same!
*The ‘How’ of the Hot Hand, Juemin Xu and Nigel Harvey, University College, London.