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Emotions

A common adage on Wall Street is that markets are motivated by two emotions: fear and greed. Indeed, I suggest that investors are affected by these emotions. However, there are other strong emotions that affect our decisions, such as hope, pride, regret, and embarrassment. No matter what the emotion, acting on it is rarely the wise the move. Emotions get in the way of making good investment decisions.

For example, in your desire to feel good about yourself, two strong emotions, pride and regret, have a strong effect on your investment decisions. In short, your investment decisions are biased by the desire to seek pride and to avoid the feeling of regret. In seeking pride, you tend to sell your winners too soon, thereby locking in the pleasant feeling that you made a good decision in the original purchase. Trying to avoid regret causes you to hold your losers too long, thereby avoiding the bad feeling that you made a poor decision by purchasing the stock. Both of these emotions affect selling decisions. These emotions consequently result in your selling good performing stocks and keeping poorly performing stocks. Unfortunately, the good performing stocks that were sold tend to continue to do well. Those dogs that you hold onto tend to continue performing poorly. This hurts your return. It also results in your paying higher taxes because you sell winners and pay capital gains taxes instead of selling losers and reducing your capital gains taxes.


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