Rule Du Jour: Rule #33 Greed overpowers Fear (Patreon)

This might sound wild, but it's spot on. I've been pondering this for ages, which is why it's Rule #33. Emotions such as greed and fear can skew your judgment, pushing you towards bad choices. This might just be the most crucial rule I've ever penned, so give yourself some time to really soak it in. There's a wealth of information here; it's almost like a book in itself. I shared the idea today on CyberBulls and many chimed in on the comments.

Here's how you can harness your psychological tendencies to make more rational investment choices:

COMPLEX EXPLANATION

My big Q is how can we control your brain to make smarter investment decisions and why is my observation that "Greed fundamentally overcomes fear in investing" is because:

• The brain's reward system releases dopamine during gains, reinforcing the desire for more profits

• The endowment effect causes investors to overvalue assets they own, making it harder to sell

• Fear of missing out (FOMO) drives investors to hold onto stocks during price escalations, hoping for even greater gains

• Overconfidence bias leads to excessive risk-taking in bull markets and false hope for reversals in bear markets

• The ventral striatum in the brain activates during rising stock prices, creating feelings of euphoria that can override rational decision-making

BREAKING IT DOWN INTO INVESTMENT RULES

• Dopamine Detachment:

  • What Happens: Your brain releases dopamine when you see your investments gain value, which can make you crave more profits, often leading to overambitious investments.

  • Investment Rule: Set strict profit targets. When your investments hit these targets, consider if holding for more is driven by euphoria or by solid fundamentals. Use stop-loss orders or take-profit levels to automate decisions, reducing the influence of dopamine-induced greed.

    

• Endowment Effect Awareness:

  • What Happens: You tend to overvalue what you own, making it psychologically harder to sell even when it's rational to do so.

  • Investment Rule: Regularly review your portfolio with a critical eye, as if you were not the owner. Ask, "If I didn't own this, would I buy it at today's price?" This can help combat attachment to assets that might no longer justify their cost or risk. You hear me say this all the time and this is when I clean house at the end of the year.

• FOMO Management:

  • What Happens: The fear of missing out can make you hold onto skyrocketing stocks, anticipating even higher gains.

  • Investment Rule: Implement a strategy where you sell a portion of your investment as it increases in value. For example, sell 25% at one milestone, another 25% at a higher one, etc. This not only secures some gains but also reduces your exposure to risk. Profit Taking Model is a more scientific version of this. Rely on the Process!

    

• Overconfidence Check:

  • What Happens: In a bull market, success can inflate your confidence, leading to riskier bets without due diligence.

  • Investment Rule: Always back your decisions with thorough research. Use checklists for investment criteria to ensure decisions are based on data, not just past wins. In bear markets, don't fall into the trap of expecting quick recoveries; instead, look for real signs of market stabilization.

• Euphoria Override:

  • What Happens: The ventral striatum lights up during market highs, creating a sense of euphoria that can override logical thinking.

  • Investment Rule: Develop a 'cooling-off' period before making big decisions during market highs. This could mean waiting a few days before buying more of a rising stock or deciding to sell. Use this time to reassess with a clear head, away from the emotional rush. By the way Perps can be just this.

    

By understanding and countering these brain responses, you can make better investment decisions that are less driven by fleeting emotions and more by enduring strategies. Remember, the goal is not to eliminate emotion but to ensure it doesn't dictate your investment strategy.