3 psychological elements to making money from ASX shares

The ability to trade ASX shares online at a moment’s notice gives us amateur investors plenty of opportunity to stuff things up.

It’s easy for amateurs to overreact to bad news, or follow the herd and buy the latest hot stock at the peak of an unsustainable run.

Most of us have done these things, especially in the early days of investing when we were still learning.

These things boil down to the unique psychological elements of ASX shares investing.

In the age-old shares vs. property debate, proponents of real estate investment will tell you one of the biggest benefits of bricks and mortar is the lengthy process and high costs of selling.

This encourages investors to stay in the game. And that’s advantageous because Australian property has a strong history of delivering excellent capital gains over the long term.

ASX shares investing is different because trading is incredibly easy and accessible.

We can log onto our online brokerage platforms and hit the sell button in a panic any time our emotions drive us to do so!

This means we have to consider our emotions when investing in ASX shares.

During 40 years of working in the finance and investment field, AMP Ltd (ASX: AMP) chief economist Dr Shane Oliver has learned a lot about the psychological elements of shares investing.

He outlined his insights in a recent blog.

Let’s check out his tips.

3 psychological elements to ASX shares investing

You need to know yourself

As a rule of thumb, Dr Oliver suggests that ASX shares investors ask themselves how they’d react if their investment suddenly dropped 20% in value.

He explains:

If your reaction were to be to want to get out, then you will either have to find a way to avoid that as you would just be selling low and locking in a loss or if you can’t then you may have to consider an investment strategy offering greater stability over time and accept lower potential returns.

Another way to avoid making snap decisions is to take a long-term approach to ASX shares investing.

This requires spending time doing proper research so you can feel confident that the companies you are invested in have great long-term prospects and can withstand short-term hurdles.

But this is easier said than done.

Dr Oliver points out that choosing your own ASX shares and managing your investments yourself “will require a lot of effort to get right and will need a rigorous process”.

He suggests:

If you don’t have the time and would rather do other things like sailing, working at your day job, or having fun with the kids then it may be best to use managed funds or a financial planner.

The crowd gets it wrong at extremes

Dr Oliver says bouts of investor irrationality often take certain ASX share prices “well away from fundamentally justified levels”.

He explains:

This flows from a range of behavioural biases investors suffer …These include the tendency to project the current state of the world into the future, the tendency to look for evidence that confirms your views, overconfidence, and a lower tolerance for losses than gains.

From this it follows that what the investor crowd is doing is often not good for you to do too.

This is referred to as the “herd mentality”.

Humans feel safer when we’re doing the same thing (like buying a certain hot stock).

Dr Oliver explains that this safety-in-numbers approach is “often doomed to failure”:

Whether it’s investors piling into Japanese shares at the end of the 1980s, Asian shares in the mid-1990s, IT stocks in 1999, US housing and credit in the mid-2000s. The problem is that when everyone is bullish and has bought into an asset there is no one left to buy but lots of people who can sell on bad news.

It pays to be optimistic

Dr Oliver points out that ASX shares have delivered positive returns in roughly eight out of ten years since 1900, while US shares have delivered positive returns in seven out of ten years.

He says remembering history and maintaining optimism will help ASX investors look past bad news and maintain a buy-and-hold strategy.

Dr Oliver concludes:

…getting too hung up worrying about the two or three years in 10 that the market will fall risks missing out on the seven or eight years when it rises.

Here is AMP’s latest forecast for ASX 200 shares.