08/18/2011 03:24 pm ET Updated Oct 18, 2011

How "Threat Sensitive" Are You to These Market Conditions?

The current markets are nervous, full of uncertainty and highly reactive to any news -- positive and negative. Investors are confused by the daily fluctuations and are challenged to maintain a sense of calm and control.

Not everyone can tolerate a prolonged roller coaster ride and some will want out. The majority of investors would rather avoid such risk, volatility and uncertainty.

There are some basic tenets of psychology that help to explain investor behavior in these uncertain times. When we're afraid, we are prone to stick to a group with whom we relate -- others who hold similar values and interests. Threat sensitivity depends on how we see or perceive our world including the market.

People who are more "threat sensitive" see the investing world as a more dangerous place and are more fearful of losses so they become driven by their fear. We often refer to the "herd mentality" to describe how these investors react to the market.

In general, investors are held captive by unpredictable yet frightening events -- they become traumatized and experience a state of panic as a result of their unbridled fear.

It's how investors cope and learn to tolerate this sense of fear that predicts whether they will panic and want out or be able to maintain their strategy and stay the course if it is still appropriate for these times and their situation.

Being able to understand how a current market situation compares to past historical events can be very helpful in giving investors a proper perspective of what they might expect. There have been numerous crises that investors have weathered successfully if they reacted reasonably and could manage their emotional reactions and maintain their strategy for the long-term.

Both my research into the attitudes and feelings that drive money management and investment behavior, and my work with investors and investment advisors tell me the following things:

  • Successful investors are in control of their emotions and are more likely to act on facts as opposed to feelings.
  • It is possible to learn successful investing just as it is possible to learn most other forms of appropriate business behavior. The first step is being self-aware, the second is to be self-confident, and finally self-motivated and responsible.

As you evaluate your current situation and feelings about the current market conditions of uncertainty, consider these points:

  • Investors are more prone to make or lose money as a function of their emotions and attitudes than on the basis of their stock selection or trading system.
  • The best system can be rendered a losing proposition by inappropriate implementation due to emotional and behavioral limitations.
  • Appropriate or successful investor behavior can be learned to a large extent.
  • Education is essential to helping investors stay in control and continue to grow, particularly in learning self-regulation and self-control.

In other words, there is a vast world of emotion under the surface structure of investing. To know and understand the motivating forces behind investing, to know and understand why one investor becomes tense about losses, why one becomes greedy about profits, and why one either overreacts or fails to react is, perhaps, more than half the investment battle won. There is a high price to pay for the kind of innocence many investors bring to their investments and even the way they interact with their investment advisors. In many cases, for investors to continue to maximize their financial returns, they must first learn to master their emotions.