With many markets and asset classes at or near all-time highs, this is a good time to take a step back and really understand the 3 types of people the market has and will continue to punish going forward.
If you find yourself in one of these three categories, you are most likely on borrowed time from experiencing losses and maybe even waterfall declines in your positions.
Most people want to get rich as quickly as possible, and bull markets invite us to try it. The Internet boom of the late 1990s is a perfect example. At the time, it seemed all an adviser had to do was pitch any investment with dotcom at the end of it, and investors leaped at the opportunity. Mass accumulation of internet-related stocks, many of them barely startups, reached a fevered pitch. Investors got exceedingly greedy, fueling ever more buying and bidding prices up to excessive levels. Like all other asset bubbles in history, it eventually burst, depressing stock prices for 3+ years.
When people are overtaken by the power of greed that becomes rampant in a market, overreactions can take place that distorts prices. On the side of greed, asset bubbles can inflate well beyond fundamentals. When the bubble does burst and investors, traders and speculators all hit the exits at the same time you have waterfall declines which equals huge losses.
Leverage is a trading mechanism investors and traders can use to increase their exposure to the market by allowing them to pay less than the full amount of the investment. Consequently using leverage in a stock transaction, allows a trader to take on a greater position in a stock without having to pay the full purchase price.
Leverage is the use of borrowed funds to increase one’s trading position beyond what would be available from their cash balance alone. Leverage, however, can amplify both profits as well as losses.
The misuse of leverage is the single biggest killer of traders. It is intoxicating, plays to the mirage that you can be a millionaire in a month if you use it, and is readily available. However, it is also the single fastest killer of accounts and so makes it to the list of those who the market punishes.
Overconfidence leads to increased trading activity, higher risk taking, and less diversification. Overconfidence is particularly dangerous to investors because it can lead to not only excessive trading, but also a failure to diversify and sufficiently to minimize risks.
In investing, overconfidence often leads people to overestimate their understanding of financial markets or specific investments and disregard all other data and/or expert advice.
Overconfident investors who believe that their exceptional skill in market timing and stock selection will lead to consistent exceptional performance typically underperform the markets over the long term. overconfidence creates a vicious cycle in which investors buy when they feel confident, sell when they get scared, miss the recovery and jump back in when the markets feel safe again.
The Bottom Line
You are the final decision-maker for your portfolio, and thus responsible for any gains or losses in your investments. Sticking to sound investment decisions while controlling your emotions, whether they be greed or fear-based and not blindly following market sentiment is crucial to successful investing and maintaining your long-term strategy.