Is it possible to master emotions when trading?

The chances are that someone you know is still trying their hand at day trading. It might be you. But even companies whose business it is to promote day trading are now warning that you are likely to lose money unless you can rein in your emotions.

Which allows me to use the most brilliant FT Money reader comment ever written: “I lost most of our money backing internet stocks 20-odd years ago, the children were young (and at private schools — ouch). When l told my wife, she asked if I’d lost the house (which we owned outright). l said, no, even l was not that stupid. She then laughed and said that it ‘doesn’t really matter much then’. I realised at that moment she was the best investment l was ever going to make and that was a totally emotional choice.”

Yes, some of the best decisions in life are made using our emotions. So, why doesn’t that apply to investing?

During the pandemic a reported 1.8mn people in the UK dipped their toes into trading for the first time. Most were motivated by the potential for higher returns than from savings account deposits, according to a 2021 survey by Consumer Intelligence for GraniteShares.

Now that cash rates are higher, this party should be over. But worrying new research from the Financial Conduct Authority shows that some low earners who don’t have workplace pensions are investing in cryptocurrencies and other risky financial products. It’s either desperation or naivety.

This group should definitely not be day trading — because let’s call it out for what it really is, speculation or gambling. The stakes are just too high for someone with no pension provision losing a hard-earned £1,000 on a punt.

If you’re at the top end of the wealth spectrum, with enough saved to afford a comfortable retirement, I have no problem with your trading “side hustle”. But I’d rather you call it an expensive hobby, with mastering emotions part of the game.

New research from City Index, the broker that supports the wilder side of day trading beyond buying shares by offering spread betting and foreign exchange trading, found more than a third of traders admitted emotions influenced their trading decisions. People aged 41-60 were most likely to have their trading decisions consistently influenced by emotions.

Whatever your means, if you’re approaching retirement aiming to fill a pensions black hole by trading, stop it now. Your additional emotional worries about money mean you’re more likely to make the wrong call. Even if you’ve no money worries, your investment decision-making is driven by a greed-and-fear response that causes irrational behaviour; buying high and selling low.

Some have tried to argue that emotions can enhance trading performance. But the academic evidence has been against them since the 1980s. Nevertheless, a 2021 Bath university study, ‘Do emotions benefit investment decisions? Anticipatory emotion and investment decisions in non-professional investors’, found the level of emotion experienced depends on context — the level of the share price at the time of trading.

Why are we like this? Experts say the evolutionary roots of our emotional responses to investing are tied to hunter-gatherer survival instincts.

Stone Age hunters had to exert more effort to avoid pain (broken leg = inability to defend or feed family for two months) than to make a gain (kill gazelle). But it also paid to take big risks — one big mammoth kill could mean a month’s protein for the tribe. Our ingrained survival instincts urge us to take risks — we frequently choose “fight” over “flight” when facing insurmountable odds (or a sabre-toothed tiger).

So the pain caused by losing money on a trade is significantly greater than the pleasure received from a gain of equal value. And it is compounded by our innate ability for self-deception. We convince ourselves that we can beat the market, that we are better at controlling our emotions than we actually are.

However, when the potential risks become elevated more conservative instincts tend to kick in. That may explain why savers held record amounts of money in cash as a result of pandemic-induced fears.

But more than £1tn of the nation’s savings is still sitting in accounts earning less than 2 per cent, while the base interest rate is 5.25 per cent, according to an analysis of Bank of England credit data. If this is your money, it’s lost out massively to inflation, and urgently needs moving to a decent rate.

Meanwhile, investment risk adviser Oxford Risk found emotionally driven decisions lose investors an average of 3 per cent a year in returns. Losses can rise to 6 or 7 per cent a year during periods of high stress, or steep volatility.

How can we combat this? The conventional advice is to drip money into investments and add on the big corrections. Keeping emotions in check may be as simple as making your password forgettable so you leave your investments alone. Or use a rules-based percentage approach, allocating a certain percentage for each theme, topping up if it gets too low and reducing if it gets too high.

Others rely on financial advisers for hand-holding when markets fall — a good “value add” for the fees paid.

Some leave their thrill-seeking to Premium Bonds, where once a month they tap the app to see if they’ve won a tax-free prize. I did a little “whoop” when I won £200 this month, but I’m sad about the prize fund rate dropping from 4.65 per cent to 4.40 per cent in March. I think that counts as a low-speed emotional rollercoaster?

But if you keep spotting investment opportunities, perhaps talking about them to family or friends, I think you need to find a way to scratch this investment itch.

Giving yourself (and your emotions) a go on the “Tower of Terror” with up to 10 per cent of your portfolio could be a good idea, as long as you ride the “Tea Cups” with the other 90 per cent.

Even if your play money doesn’t fit your normal strategy, it might still meet a financial adviser’s approval. Whether it’s investing in an Aim-listed company, trading the FTSE 100, bitcoin or an urge to try your hand at spread betting, it keeps you current, with some of the investments in the news being your investments.

That makes investing fun and interesting, and can help you to stay the course, keeping your emotions in check for the main, “boring”, portion of your portfolio.

Moira O’Neill is a freelance money and investment writer. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’neill@ft.com