Don't follow the herd - Think rational

"There is a difference between actual risk and perceived risk. The perceived risk is the lowest when it is actually the highest and it is the highest when it is perceived to be the lowest." - wrote Leon Levy in his book, "The Mind of Wall Street"

Warren Buffett said, "You should be greedy when others are fearful and fearful when others are greedy."

If we look at the above two sentences, we can see the link. When others are greedy, it is generally when the perceived risk is the lowest. As Leon Levy has put, this will be the time when the actual risk would be at the highest. Similarly, when others are fearful, the perceived risk is at the highest, which means the actual risk is likely to be at the lowest.

The time to invest is when the actual risk is at the lowest. However, the perception of risk is a function of the recent past - known as the recency effect.

It is so common that many investors take decisions based on the experience or data pertaining to last few months or years. Such short-term history plays heavily on mind when one considers any investment. This past performance frames the perception of the risk and that is exactly what Leon Levy highlighted.

This is simple to talk about, but very difficult to implement. Since we are social animals, we are wired - for our survival - to be with the group. In which case, when the others are greedy, it is natural to be greedy ourselves or fearful when others are fearful. 

Is there a way to overcome this? Well, yes, there is a small idea

When you have a strong urge to do something - don't do it immediately. Take some time to study the option and think about the possible downsides. Discuss with some experts. Take their views. Only after such case, take a decision. There is no urgency and the world is not going to change in a day or two.

Because we are normal human beings, we are not rational. Emotions play a major role in our thinking and decision-making. Very often, we make choices for emotional reasons and the outcome may not be in our own best interest.

- Amit Trivedi

The author runs Karmayog Knowledge Academy. Views expressed here are his personal views. He can be reached at amit@karmayog-knowledge.com.