Emotional investing: why 95% of small investors fail and how you can be part of the 5% with One-Signal
10 May, 2022

It is commonly stated that between 80% to 90% of private investors and speculators lose money in the stock market. A surprisingly high number of people put their money in the stock market, further financing an industry that has grown to unimaginable proportions. There is a common misconception that long-term investment techniques, i.e. avoiding the noise and bustle of day trading can produce above-average returns. Some say that the buy-and-hold strategy is unbeatable since investors only make one decision, and timing the market is ineffective in the long run. We will quickly dispel some of these persistent beliefs and demonstrate how you can be part of a small minority of winners. There are entire shelves dedicated to books claiming that the long-term method (buy-and-hold) is better compared to the market timing strategy. One specific research result from the 1990s is frequently cited, which calculates how much an investment’s performance would suffer over a certain period of time if the worst 10 days were avoided. It takes a lot of practice and experience to avoid the bad days and only stick to the good ones.

Numerous studies have thoroughly evaluated various explanations for private investors’ poor performance. The main reason, however, is emotional trading. Focused and open-minded individuals can learn lessons from their experiences and unpleasant losses, while many others leave the stock market disillusioned and disappointed, without getting anything in return for their apprenticeship money (losses). Only a few individuals become successful traders, the rest turns their back on the entire circus and develops an aversion to anything related to the stock market. However, this does not have to be the case for everyone. Capital markets remain full of excitement and adventures, but above all, they are the best teacher if one is persistent enough.

One-Signal proves how easy it can be for private investors to beat the overall stock market without taking unnecessary risks through leverage or other bad decisions, which is demonstrated by our performance. We have built our systems exclusively on the assumption that market participants make irrational decisions and are therefore frequently wrong. The key to our success is the psychological analysis of market players. For some time now, even the most powerful investors have increasingly based their decisions on market mood.

Emotional heuristics

Scholars have discovered that when faced with complicated and ambiguous options, humans make predictable, non-optimal choices due to heuristic simplification.  We will explore some of these heuristics:

Overconfidence Bias is a general trait among investors which leads to overestimating their own abilities when it comes to picking investments or entering and exiting positions. It often encourages investors to trade more or take riskier positions which they consider a “sure” investment. Alternatively, it might also lead to individuals thinking that they have access to superior information, which is why their decisions will always be better compared to other investors.

Representativeness bias is a psychological bias which asserts that, in the face of uncertainty, investors are more likely to assume that a history of exceptional performance by a certain business is "representative" of the overall performance that the firm will achieve in the future. This heuristic causes investors to overreact to relevant and similar information about a firm's prior performance, such as similar consecutive earnings surprises. Another interesting aspect is that individuals tend to attribute good characteristics of a company directly to its stock. These companies often turn out to be poor investments.

Anchoring bias is a psychological heuristic which occurs when investors give importance to irrelevant and unnecessary information, such as the purchase price of a security, as a fixed reference point (i.e. anchor) for making subsequent decisions about that security. This bias can lead to, among other things, buying overvalued securities, or selling undervalued securities.

Confirmation bias refers to people's inclination to pay close attention to information that confirms their beliefs while ignoring information that contradicts them. It impacts how we gather information, but they also influence how we interpret and recall information. For example, people who support or oppose a particular issue will not only seek information to support it, but they will also interpret news stories in a way that upholds their existing beliefs, or remember details in a way that reinforces these attitudes.

The endowment effect is a mental process in which the value of a financial instrument varies depending on whether one possesses it and is faced with its loss or whether one does not possess the object and has the potential to gain it. If an investor owns the stock and is therefore faced with its loss, the loss is perceived to be greater than the magnitude of the corresponding gain if the object is newly in possession. This bias is similar to loss aversion, where human beings perceive losses asymmetrically more acutely than similar gains.

Herd behaviour is a phenomenon in which individuals act collectively as part of a group, frequently making group decisions that they would not make alone. This behaviour has 2 explanations: societal pressure to conform, acting in the same way as others, even if it goes against their natural tendencies, and the difficulty for individuals to accept that a large group can be wrong, therefore following the group's lead in the false notion.  

At One-Signal, we believe that markets are driven by fear and greed, as market participants make irrational decisions. Our signals are therefore solely based on sentiment indicators, which reflect how market participants feel. Our system pinpoints sentiment trends and follows these until the exaggeration phase to then change direction strategically. One-Signal was developed by our CEO, after realising that most personal trading mistakes were emotional. Our goal is to cut through the noise and emotions when trading. Our subscribers receive one word in one email per day, which is an indication to buy or to sell, the information is reduced to the maximum. Our aim is to alleviate the stress investors face every day, as we believe that everyone has the right and the capability to make decisions without emotional stress.

 

 

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