It is not the first time I have been faced with a flurry of concerns, questions and apprehensions towards investing.

The act of investing is perceived as a dominion left only to the extremely qualified, highly intelligent number crunchers. As much as I believe a certain amount of grey matter is required, there is one misconception I would like to tackle – the fallacy that successful investing is attributed to raw intelligence alone.

On the contrary, I feel it has got more to do with mental discipline and commitment towards your approach, and well, so does Warren Buffet.

As the widely renowned billionaire investor once quipped: “Success in investing doesn’t correlate with IQ once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

So this brings me to discuss and investigate the psychology of investing; what makes good investors tick, what sure fire rules are they adhering to? And what is the successful investment path they seem to be travelling along? We see that experts in the field of behavioural finance have a lot to offer in terms of understanding psychology and the behaviours of investors, particularly the mistakes they make.

If an investor is able to identify and correct investing mistakes, and instill a psychological discipline in their approach, this will lead to greater profits and success.

The following are some errors that investors should develop a conscious awareness of, in order to minimise their negative affect on their investments:

Overconfidence when investing: overconfidence refers to our boundless ability as human beings to think that we are smarter or more capable than we really are. Overconfidence hurts us as investors when we believe we are better able to spot the next ‘big thing’ than another investor is. Odds are, we are not. Studies show that overconfident investors trade more, which raises costs plenty and rarely rewards the effort.

Trading costs in the form of commissions, taxes and losses on the bid-ask spread have been shown to be a serious damper on annualised returns. These frictional costs will always drag returns down.

Selective memory: few of us want to remember a painful event or experience in the past, particularly one that was of our own doing. In terms of investments, we certainly do not want to remember those stock calls we missed (had I only bought Asos (ASC) in 2008), much less those that proved to be mistakes that ended in losses.

Instead of remembering the past accurately, we selectively remember information to suit our needs and preserve our self-image. Incorporating information in this way is a form of correcting for cognitive dissonance, a well-known theory in psychology, which suggests that our psyche corrects the uncomfortable holding of two seemingly disparate ideas, opinions, beliefs or behaviours at once.

Representativeness: this is a mental shortcut that causes us to give too much weight to recent evidence, such as short-term performance numbers, and too little weight to the evidence from the more distant past. As a result, we’ll give too little weight to the real probability of an event happening. Investors tend to become more optimistic when the market goes up and more pessimistic when the market goes down.

Self-handicapping: this bias occurs when we try to explain any possible future poor performance with a reason that may or may not be true. A typical example would be that you say you are feeling unwell before an exam, so that if, in the eventuality that you do not pass, maybe it was because you were feeling unwell.

As investors, we might succumb to self-handicapping by saying that maybe we did not spend enough time researching a stock as we had done in the past, just in case the investment does not turn out well.

Loss aversion: many investors will focus obsessively on investments that are in the red and not give as much importance to those that are doing well. Investors have shown they are more likely to sell winning stocks as opposed to not wanting to accept defeat in the case of the losers. To be successful, the opposite stance needs to be adopted, cut your losses short and let your profits run.

Herding: there are thousands of different investments, and it is impossible to follow all of them. Investors are bombarded with information about investments from every angle; however, unfortunately, in many cases it has come to the public’s attention because of its strong previous performance not because of an improvement in the underlying business. Following a tip under the assumption that others have more information is a form of herding behaviour.

In order to minimise the possibility of falling into some of these ‘traps’, it is suggested that each person develop his own investment philosophy which sets the direction and parameters of his portfolio of investments; ideally, get it down in writing.

Prior to taking an investment decision, one should refer to this philosophy statement to ensure that his thinking is in line with his investment rationale, that the decisions one takes are unaffected by current emotions and that a methodological awareness is created.

This article is prepared for information purposes only and does not constitute investment advice or marketing communication.

Simon Psaila is a trader at Calamatta Cuschieri Co. Ltd.