Making Rational Investment Decisions

Bias can have a powerful effect on our rational investment decision-making process when investing in unit trusts. If someone tosses a coin 10 times in a row and each time it lands on heads, then what would your choice for the 11th toss be? You may assume that the trend continues and call heads or, believing the trend will buck, you choose tails. Statistically though, there is still a 50% chance that it will land on either heads or tails.

Bias is the reason most of us tend to choose either heads or tails. When we are presented with information, we tend to interpret it according to our personal biases. Our biases and our reaction to the information may prove detrimental when we apply it to investments.

As a counter example; consider an opaque bag containing 50 white and 50 black marbles. If 10 black marbles were removed from the bag, what colour would the 11th marble be? Most of us would say white since the probability of picking out a white one is higher (50 of the 90 remaining marbles are white) than picking a black marble. Unlike the example of the coin toss above, the information we are presented with between removing the 1st and 10th marble is relevant in guiding our choices for the 11th marble.

Emotions may hinder investment success

Heuristics are shortcuts our minds develop that allow us to analyse information and rapidly make decisions. They make our lives easier, but may also lead to errors in judgement.

Scientists have identified over 100 behavioural biases. These include: Confirmation bias, which means we search for information to support our views or beliefs and over-extrapolation, which occurs when we depend too much on a particular piece of information. The more common biases we all experience are fear, overconfidence and greed.

These biases may affect your behaviour, and therefore your success, as an investor.

A good example is the investor behaviour surrounding the global financial crisis. In South Africa, the stock market yielded returns of close to 36% per year for the 5 years prior to the crash in 2008. This lured investors in droves. Many investors paid overly inflated prices, by investing at the top of the market. Then followed one of the worst sell offs in market history. Approximately R9 Billion was withdrawn from property unit trusts and equity in the first three quarters of 2008 as fear-gripped investors exited the market. This meant that investors locked in their losses.

Try not to lose your head

Investors who remain calm during times of uncertainty are often rewarded for their patience. An investment at the peak of the market in May 2008, would have incurred significant losses by November 2008. But this is not the full picture as the market recovered 2 ½ years later and any investors who did not succumb to their emotions made back any losses and, in absolute terms, more than doubled their money by September 2016.

Don’t toss coins, pick marbles

Many people who invest use the same heuristics as they do for the random coin toss. This often results in a poor outcome. However, assessing information and using it where relevant (i.e. the marble in the bag approach) tends to yield better results.

How can we overwrite these biases? Believing the investment philosophy developed by your investment manager and understanding the unit trust you invest in makes it a bit easier to sit through market fluctuations. This allows you to benefit from the upswing when it does come around. Rational thought over emotional response is vital to a successful investment.

Find an investment strategy that is tailored to your needs, risk tolerance and time horizon. This will help take the emotional element out of your decision-making. Long-term strategies should not change if markets are volatile. An independent financial advisor can help you stay focused on your goals even when your emotions threaten to overpower you.

 

How to Choose Your CFD Broker for Online CFD Trading

Have you ever wondered how to choose your broker for online CFD trading? This post covers various types of brokers and vital tips to help you select the right broker.

Online CFD trading offers opportunities galore to make money; however, you need a good broker who can handle the execution of trades in an effective and professional way. Picking the right broker for trading is as important as your greenbacks are and making the right choice can be an uphill task, particularly when the online broker market has become increasingly competitive. Nonetheless, there are differences in terms of cost structures and services rendered and these differences require careful deliberation before making a choice.

Before you get to know how to choose your broker, let’s take a look at the types of CFD providers-

  • Market Makers OR CFD Agents
  • Direct Market Access Providers

Market makers and DMA providers are quite different from each other. They are different in terms of:

  • Asset Index
  • Cost of Trading
  • Order Execution
  • Trading Platforms
  • Company Size

So, what are the crucial factors that you must take into consideration while you choose a broker? Let’s take a quick look:

Online CFD Trading Security of Funds

Ensuring security of your funds is the most essential thing to do before opening an account. How should you go about it? Find out if the CFD broker of your choice is regulated or not. Also, check out the website, testimonials and user reviews. Lastly, make sure that the reviews you are using are reliable before making any decisions.

Broker’s Fee & Commission

Broker’s fees and commissions must be thoroughly read, analyzed and understood before you hire him or her. Broker assisted orders are prone to huge discrepancies in charges. Compare the fee and agreement offered and if you find the fee too good to be true, then you must go through it again. Complex or unusual fee structures often have hidden fees which are sure to consume your profits.

Does Your Broker Understand the Market Well?

It is extremely important for your broker to have a good understanding of the dynamic online CFD trading market. A broker with good technical knowhow and experience not only makes it a cakewalk, but also ensures good returns.

Trading Platforms, Trade Assets & Funds

After you are done with your thorough research and found some good and professional CFD brokers who are regulated, you need to dig for some more information. Find out what assets are available for you to trade on.

Besides, fund methods made available by the broker should be convenient for you too. While you compare various brokers, watch out for the trading platforms they make available for you. While some provide just a web trader platform, others offer Metatrader-4as well.

And Finally, Discounts & Rebates

Determine whether you are going to trade heavily or not. If the answer is yes, you should be looking for a trading rebate plan. These plans make you eligible for receiving cash-back promotions. Rebate, on the other hand refers to making money on the basis of trading volumes.

Before you open an account…

If you are looking for more information on trading pairs or on how online CFD trading works you can ask for more detailed information about CFD trading as well any other concerns or questions before you open your account. Trust and clear communication are important in establishing a good working relationship between client and broker.