Behavioural Finance for Cryptoinvestors #3

This time we focus on emotions and the importance of a consequent investment strategy

Regret Theory

In essence, regret theory states that human beings anticipate possible regrets when making a decision. We have an inner fear of regret, we fear making false decisions. In order to avoid or minimise the pain or guilt we feel, having made a wrong decision, we tend to alter our behaviour which may end up being irrational at times.

In investing, regret theory can mostly be observed when our investments are decreasing in value. Initially we feel having made a wrong investment. Now we face a choice. Either we sell our investment with a loss or we keep holding (or hodling ;)) on to it. The more rational approach would be to sell thereby realising the loss. Think of an exit strategy you have prepared for the case of a losing investment. Realising the loss however means, that we irreversably „uncover“ our mistake. Since we fear the regret and the embarrassment that comes with reporting our loss, we may prefer to hold on to the losing investment, abandoning our previously established exit strategy.

Definition (source – Investopedia): An exit strategy is a contingency plan that is executed by an investor […] to liquidate a position in a financial asset […] once certain predetermined criteria […] has been met or exceeded.

Exit strategies are an important means for investors to strategically plan their investments and seperate themselves from their emotions. However many an investor fails staying true to them due to the fear of regret.

Problem of Inertia

A synonym for inertia is procrastination. It means that we fail to take action on things that we agreed upon. Very similarly to regret theory, inertia hinders our ability to take action. While regret theory is mostly related to losing investments, inertia is a general problem that can appear in any market situation. Using the previous example of an employed exit strategy, inertia could hinder us from cashing out on successful investments, in other words ignore our exit strategy. Inertia is very common in the world of investing because the investment process is future oriented and can be very confusing at times. A confusing setting encourages us to take the path of least conflict. That means that often times we tend to wait and see rather than take action. This may reduce our potential gains.

Again, it is important to have a proper trading strategy and hold on to it. Try not to become irrational!
Automation can help reducing inaction. For example you could use an automated savings or investment plan to fund your portfolio on a regular basis.
Reminder apps and stop-limit orders can help you to avoid inertia and hold on to your investment strategy.

If you liked this article, feel free to read the previous installments.

https://steemit.com/behavioural/@smoothlarry/behavioural-finance-for-cryptoinvestors-1

https://steemit.com/trading/@smoothlarry/behavioural-finance-for-cryptoinvestors-2