I wrote this post on Emotional Intelligence for Money Mini Blog which I’ve got permission to republish here. It’s an important post because it looks at an area of investing that’s largely overlooked – the investor himself or herself and what’s going on beneath the surface. I enjoyed writing it so I hope you enjoy reading it. Tim
If I asked you to think of ways to be more successful as an investor, you’d probably suggest studying the markets in greater depth or gaining more experience. Maybe looking for a mentor or trying out a new strategy.
But what about increasing your emotional intelligence?
As anyone who’s ever made a rash move in the heat of the moment and looked back in horror will know, our psychology can have a huge impact on how we make decisions under pressure. This is especially true of trading.
Let’s take a deep dive into emotional intelligence and how mastery can increase our profitability when trading.
What is Emotional Intelligence?
Emotional intelligence (EQ) is a term thrown around a lot, but I’m going to use a tighter definition.
In everyday life, we say “emotional intelligence” to describe our ability to read other people and respond appropriately. We think of it as a soft skill for job interviews and a tool to keep everyone happy in group situations.
Actually, it’s a lot more complex than that. There are differing theories about EQ, especially regarding how we can measure and develop it. But most researchers agree EQ is about more than just handling social situations — it also encompasses our ability to understand and control our own emotions.
What could be more vital to investing?
Emotional Intelligence for Investors
One of the most prominent psychologists to study emotional intelligence, Peter Salovey, explored the link between emotional intelligence and investor behavior. His research for the CFA Institute with a behavioral economist and Vanguard principal gave a different interpretation to what most people think of as EQ.
The paper defines emotional intelligence as someone’s effectiveness at recognizing and regulating emotions while solving problems. It’s something we can easily apply to trading.
An investor must solve a problem every time they make a decision about buying, selling, or holding their assets. Those with low emotional intelligence follow their impulses without even realizing it, whereas high-EQ individuals are able to take a step back.
Investors with high emotional intelligence are hyper-aware of their instincts and don’t trust them immediately. They might still panic if a stock they bought plummets in value — but instead of giving in to their inclination to sell, they calm themselves down and assess the situation rationally.
Don’t believe me? The CFA Institute research also found a strong relationship between emotional intelligence and financial decisions among Vanguard investors. It affected both the frequency of transactions and the type of investments chosen.
Why Investors Need to Focus on Emotional Intelligence
To understand why emotional intelligence is important, we only have to look at why so many who are drawn to trading or investing end up losing money. In fact, it’s fair to say that the majority of those who come to the markets, lose money.
Trust me — between 69% and 79% of retail clients aren’t profitable, according to data from spread betting companies in the UK. Many of these people are smart and may be quite successful in their careers.
They come to the market thinking they can replicate this success with their trading and investing. Perhaps this could be the behavior that can foster business success often doesn’t fly in the markets.
We need to adopt a different approach.
Investing is Easy
When it comes down to it, investing isn’t particularly difficult. That might sound strange coming from someone who has spent thousands of hours learning how to invest and reading books on the topic, but bear with me here.
Sure, there’s no end of concepts to get your head around and new strategies to learn. But ultimately, all the information you need is already out there.
Learning enough about investment to get started only requires some basic research. There are many books out there, including those written by Warren Buffet, the most successful investor of all time. Why can’t all investors adopt Buffet’s strategies and be just as successful?
I think you know my answer.
Let’s take something as simple as investing in a diversified index fund as an example. All you need to do is figure out which fund to use, find a broker, and make monthly contributions. No fancy trading strategies — you can just leave your money in and let it grow.
Yet some people still panic when they see their investments’ value decline during a market crash or become overconfident when they’re doing well.
In fact, research shows people who check their investments and trade the most earn less money from investing than passive investors. Clearly, making profits from investing is about more than grasping the basic principles.
What’s the difference between the average trader who understands the theory but struggles to implement it and a successful investor like Warren Buffet? There may be a few factors, but emotional intelligence is sure to play a role.
Money is Tied Closely to our Psychology
We all have different money psychology, meaning we view financial decisions through a lens unique to our personality and experiences.
Researchers from Dongbei University studied how the Big Five personality traits (openness, neuroticism, extraversion, conscientiousness, agreeableness) affect how people trade after receiving financial advice. They found that those with open-minded or neurotic personalities are the most vulnerable to trading excessively.
The best thing we can do for ourselves is to develop awareness.
Investors like Buffet have formed a specific style and process for investing that matches their temperament. This is no easy task — it takes years of observing your behavior and figuring out how to play to your strengths — but well worth the effort.
No two investors are the same. You won’t get the results you want by copying somebody else’s strategy — you could both have very different money psychologies.
Instead, your strategy should depend on your personality, and your personality should fit your strategy. So, don’t feel bad if Warren Buffet’s lessons didn’t quite sink in for you.
It’s tricky to figure out what your money psychology is. However, I’ll outline my suggestions for developing your strategy later.
Watch Your Beliefs
It’s not just your personality that you need to be careful of; it’s also your beliefs and self-perceived status.
Do you have a strong identity as a master trader or pro-investor? This is probably bad news for your profitability, as you might want to make risky trades to prove your prowess. Be sure to keep your ego in check.
This can also link to the concept of fixed versus growth mindsets. If you have a fixed mindset, you believe you’re either inherently good or bad at investing. In contrast, growth mindset investors realize anybody can learn how to invest effectively.
Those with fixed mindsets may struggle to take a loss because they think it reflects on their ability as an investor — or even their overall intelligence. They’ll do anything to prevent that loss, even if it’s incredibly risky.
How can we fix this? By working on our emotional intelligence.
How to Improve Your Emotional Intelligence
Improving your emotional intelligence is all about observing your reactions and feelings when you trade.
How does it make you feel when you lose money? What about when you make money? Do you have a strong bias toward action or struggle to step away?
Taking note of these tendencies is key to developing emotional intelligence. It’s difficult to do when trading alone, but using simulated trades or joining a group can help.
Make Use of Simulated Trades
We should all embrace our mistakes when investing — it’s part of improving. But it’s better to make mistakes when trading $10 and not $10,000. Or, even better, when trading nothing at all.
Most popular brokers and trading apps have free simulations you can try so you can get to grips with trading without risking losing your money. For instance, Trading 212 lets anyone open a free practice account to simulate trading forex, gold, stocks and more.
This is the perfect way to unpack your emotional intelligence and investor psychology without taking any risks.
Join a Group
If you’re struggling to hold yourself accountable, you might find it useful to join a group.
Ed Seykota’s Trading Tribe has tribes all over the globe, I belong to the one in London. A small group of traders meet regularly to work through what feelings and emotions might be impacting on our trading. As Seykota’s book suggests, it’s best to work with your peers to master our emotions and improve at trading.
Seykora points out that, left alone, it’s hard for us to accept our shortcomings and be honest with ourselves — we need someone to call us out!
Although the focus on the ego and subconscious might seem too new age for the classic trading crowd, don’t discredit it. Joining a “tribe” is the perfect way to find alignment between intention, emotions, behavior, and discipline.
Instead of focusing on the result of a trade (winning or losing money), let it go and hone in on the process.
There’s far more to emotional intelligence than just teamwork and listening skills; it can also make or break your investment strategy.
Instead of finding an investor you admire and trying to copy their strategies move by move, focus your attention inwards. Who are you and what does trading bring out of you?
Paying some attention to emotional intelligence can pay serious dividends — both literally and figuratively.
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Tim Thomas has no positions in the stocks, forex, ETFs or commodities mentioned.
Featured image credit: Unsplash.