What are the things that we need to leave separated when we trade or invest? Emotions. Emotions like greed and fear do not have a place in finance and investments. We should not cloud our judgments with these. There is a concept that we call emotional neutrality, where people need to remove emotions, especially greed and fear, when making decisions involving finances and investments. But why? It is best to make final decisions objective. There should not be any psychological influence to arrive at the best possible decisions.
Diving deeper into emotional neutrality
There is a hypothesis called the “efficient market hypothesis.” It is an assumption that investors maximize all information given about the stocks when making relative decisions. It also assumes that investors are rational. They do not let emotions influence them. So, a group that makes decisions create an accurate reflection of all the available information. It helps when determining market prices.
An investor’s emotion may seem like it does not matter too much. However, some researchers say that it has a massive effect on finance and investments. It may bias decisions and influence the market from efficiency.
The emotional neutrality concept
It is typical for humans to feel emotions. Hence, the concept says emotional neutrality came from human reactions when they experience profit and loss. It is natural to feel happy when trades generate profit or feel disappointed or scared when trades create losses. However, it will be helpful if investors separate these feelings from their trading decisions to have a better trading performance. On the other hand, this theory assumes that people have preferences and constraints. Hence, they can make rational decisions when they weigh the expenses and advantages of every available option. Behavioral economics and finance researchers cannot stress this enough, and it is because of different cognitive biases. However, the same is not valid with behavioral economists that draw on psychology and economics. They say that people are irrational and they cannot make sound decisions.
Contrarian strategy and emotional neutrality
Have you heard of contrarian strategy? This is a strategy that investors adapted to try to buy securities when many people sell them and sell when many people buy. As the name suggests, contrarian investors go against the flow. What does this mean? It means that investors should be emotionally neutral so their emotions do not impact their trading decisions. They become more profitable. If many people are negative about a stock, the price will decline so low. This will spark an interest in contrarian investors. Also, they buy distressed stocks so they can sell them later once the company recovers. This will boost the stock’s value. This scenario is also attractive for contrarian investors because they can almost see that the securities will generate more gains than usual. On the other hand, the opposite will happen if people would be overly optimistic about “hot” stocks.
Let us summarize
Emotion neutrality means making rational decisions where people separate their emotions like greed and fear in financial and investment decisions. Why? It is because emotions can favor specific investment decisions that might not help in becoming more profitable. Some people use a contrarian strategy where investors buy when many people sell, and they sell when many people buy.