Investing Lesson: Avoid the Impulse Trap
If you’re just starting to dabble in the stock market, it’s easy to get caught up in the excitement. News headlines flash, stock prices jump, and the urge to buy right now can be strong. However, acting on impulse is a common trap for many individual investors, and understanding this tendency can help you make more thoughtful decisions.
The Six-Minute Decision: A Rush to Buy
Research analyzing investor behavior reveals a startling trend: “the median investor often spends only about six minutes researching a stock before buying it”, especially if that stock is currently making headlines.
Think about that – just six minutes to decide where to put your hard-earned money. That isn’t as long as some people take in considering the color of their new cell phone!
Even more telling is how that limited time is spent. Studies estimate:
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The vast majority of this research time often involves looking at a stock’s recent price chart. In fact, a large percentage (around 73%) of these chart views focus only on the last day’s trading or even less.
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Analyzing the underlying company’s financial health – its earnings, dividends, and other fundamentals – receives minimal attention, perhaps only around 14% of that brief research window. That is 50.4 seconds on “the fundamentals” which are near and dear to this man’s heart, soul, and most of all brain.
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Examining crucial risk statistics, like how volatile the stock is, gets even less focus – estimated at a mere 1% of the total research time (just a few seconds!).
While not all investors are impulsive (some do extensive research), a significant number spend virtually no time digging into a stock before purchasing it.
Why Impulsive, Attention-Driven Buying Often Backfires
This pattern of “attention-driven buying” – purchasing stocks primarily because they are in the news or showing sudden price movement – often leads to subpar results. Here’s why:
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Underperformance: Studies suggest that, on average, the stocks individual investors buy impulsively tend to underperform the stocks they sell. Buying based on hype doesn’t reliably generate superior returns.
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Paying a Premium: Stocks that are constantly in the news or have exciting stories often attract a lot of attention. This demand can inflate their price, meaning impulsive buyers may end up overpaying.
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Ignoring Solid Performers: Conversely, some of the best-performing stocks over the long term belong to companies that are relatively “boring” and don’t generate constant headlines. These opportunities might be missed by those chasing short-term excitement.
A More Rational Approach for New Investors
While picking stocks that consistently beat the market is incredibly difficult even for professionals, you can improve your odds by avoiding impulsive decisions. If you’re determined to pick individual stocks, consider these steps:
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Slow Down: Resist the urge to buy immediately just because a stock is trending. Give yourself time to think, ask questions, and research.
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Look Beyond the Daily Chart: While price history matters, focus on more than just the last few hours or days. Understand the longer-term context and if this is a cyclical stock moving up and down in price due to the seasons.
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Analyze the Fundamentals: Spend time understanding the company behind the stock. What does it do? Does it have a great competitive advantage – a MOAT.
Is it profitable? Does it have debt? What are its annual growth prospects? Does the company have an experienced and well-respected leadership team of management.
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Assess the Risk: Look into the stock’s volatility and other risk measures. Does this level of risk align with your comfort level and overall financial goals? This is particularly vital if your investments aren’t spread across many different assets (i.e., if you aren’t diversified).
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Consider Trading Less: Often, trading less frequently and focusing on holding a small quantity of quality investments for the longer term yields better results. Constantly jumping in and out of stocks based on social media and even the news is usually problematic. You may score a couple of times but not consistently. You only need a handful of stocks to do well, 5 or 6 is a number often quoted, keep only one company in each sector. Here is an “example”: transportation (Uber), housing and repair (Home Depot), staples like grocery (Walmart), Technology (Amazon), drilling / minerals (Exxon), pharmaceutical (Johnson & Johnson). Even well-versed traders generally only have 15 – 20 organizations in their portfolio, these are people like me that have the job of research as full time.
The Bottom Line
Being aware of the tendency towards impulsive, attention-driven investing is the first step. By dedicating a little bit more time to researching fundamentals and risk, and less time reacting to short-term noise, you can build healthier investing habits and potentially achieve better long-term results.
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