Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

TD Ameritrade Holding Corp. (AMTD): Good Habits Make Great Investors

It turns out, however, that this is the wrong way to think about the issue. Much like the data on an old disk drive, studies show that bad habits never go away, or at least not entirely. Instead, they can only be overwritten by better ones. Psychologists refer to this as “habit reversal” — sounds Orwellian, I know.

A habit can be broken down into three distinct parts, which together form a “habit loop.” First is the cue, which triggers your brain to initiate the loop — say, watching CNBC or reading an alarmist headline. Next is the routine, which consists of the behavior itself — for instance, selling a stock in panic based on what you just learned. And finally is the reward — in our case, the rush of relief that comes over you after the trade.

With this in mind, the objective isn’t to eradicate the entire habit loop, but rather to identify the cues and rewards and then swap out the undesirable routine for a new one. “That’s the rule,” Duhigg explains, “if you use the same cue, and provide the same reward, you can shift the routine and change the habit.”

So how does this translate into better investing? If there’s one thing we know for certain, it’s that frequent trading is, to put it in the words of the seminal study on the issue, “hazardous to your wealth.” As the authors show, investors who traded the most ended up underperforming the S&P 500 by more than six percentage points per year.

“That’s a staggering amount,” my colleague Morgan Housel pointed out. “Over time, it’s the difference between a good retirement and no retirement.”

The trick, in turn, is to trade less frequently. One way to do so is to avoid cues that lead you to do so — watching CNBC, for example. The other way, as I’ve discussed, is to swap out the old routine in favor of a new one — that is, use habit reversal techniques.

I recommend the latter. And, more specifically, I recommend that you bookmark this article on discipline and successful investing and reread it as your routine every time you’re confronted with a cue to impulsively buy or sell a stock. I can almost guarantee that doing so will save you money and increase your returns.

The article Good Habits Make Great Investors originally appeared on and is written by John Maxfield.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends and owns shares of TD AMERITRADE.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.