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The Role of Psychology in Stock Market Investing

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Investing in stock markets is a high risk, high reward business. While the majority of small investors lose money in the stock markets in India, a small percentage of investors have managed to create massive wealth from stock markets.

So what is the reason why only a tiny percentage of retail investors are successful in Indian stock markets?

The key here is the behaviour of the stock market investor. Psychology is the study of the mind, how it works, and how it might affect behaviour. Psychology is a big part of the stock market investment and if well understood, can help prevent financial setbacks.

Behavioural finance has managed to bridge the gap between theory and practice by scientifically recording human behaviour.

\”Winners think differently. It\’s not how much you know, even though knowledge is essential. It\’s not how hard you work, even though nothing worthwhile is achieved without hard work. The real difference lies in the way winners think\”-Colin Nicholson, Author of Building Wealth in the Stock Market.

Let’s take a look at different types of investors in the stock markets in India

Active Stock Market Investors:

Active stock market investors use an investment strategy which involves continuous buying and selling activity. They usually dismiss long-term trends and focus on short-term profits

Passive Stock Market Investors:

Passive stock market investors use buy-and-hold strategy for the long term and do not seek to profit from short-term price variations or market timing. 

Emotional Stock Market Investors:

Emotional stock market investors are the ones who tend to hold on to a stock forever, irrespective of factors which negatively impact the stock and make it less favourable as compared to its peers.

Copycat Stock Market Investors:

Copycat stock market Investors tend to ape stock portfolios of expert/star investors in the hope of mimicking their returns without understanding the reason behind it.  While it does look simple in theory, in reality it is often much harder as copycat investing in stocks of successful investors has its own set of risks that most people don’t understand. Know more about perils of copycat investing.

Investing psychology is very important when investing in the stock markets in India. Behavioural finance can help you to prevent terrible investment mistakes. Investing mistakes can be costly and deliver losses, even if the stock market performs well or is in a bull run phase.

Different investors have different mindsets. In broader terms, they can be classified into \’Optimists\’ and \’Pessimists\’. Optimism fuels a bull run in the stock market, whereas pessimism leads to a bear market.

When the stock market is in a bull phase, stock market investors become greedy after observing that Rs. 50 share has rallied to Rs. 100. Now they start to buy, and the shares price touches Rs. 150 making it overpriced. In a correction phase, when the stock price comes down to 80/-, stock market investors see a sharp fall. Pessimism starts to surround them, which leads to fear and begin booking a loss.

In this case, investors who entered the stock at Rs.100 (higher price) and sold it at Rs.80 (lower price) suffer a loss of Rs.20 per share. Some stock market investors wait further and fall in the loser\’s trap.

When the stock further falls to Rs.50, stock market investors are in a dilemma whether to exit entirely by booking massive loss or wait for a bounce back to exit. If the stock market investor exits at Rs.50/- he ends up losing 50% of his capital invested. Such situations are common among most stock market investors who follow the herd mentality.

The basic rule for success in stock markets in India or anywhere in the world is to buy at a low price and sell at a high price. Even though this looks pretty simple most stock market investors make mistakes while following this rule. On the contrary, they purchase stocks at high prices and to sell them off when the prices are down making losses and end up blaming stock markets.

Your psychology determines your success or failure in stock markets. 

Have you heard of legendary investors such as Warren Buffet, Benjamin Graham, Mark Mobius, George Soros, Peter Lynch and John Templeton? Unusual psychological traits, including the ability to think differently from others, has made them one of the wealthiest persons in the world.

If you follow the herd mentality and do what majority of the small investors do in stock markets, you may make some modest gains in the short term, but incur huge losses over the long term. However, if you want to be successful in stock markets, you must think and act like successful investors in the market.

It requires is a change in your attitude and a clear vision. Just ignore the short term ups and downs of the stock markets in India. Think long term and think big. Invest in quality stocks and let your money work for you. Click here to know more.

Read more:  How Long-term investing helps create life-changing wealth – TOI

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