Emotions is what makes us human. Unfortunately, emotions also make us bad investors. As a powerful force, emotions has the strength to often shadow intelligence, rationale and logic. And as investors, it does hurt us. It also drives our investment decisions most of the time, knowingly or unknowingly.
THE CYCLE OF MARKET EMOTIONS :
Markets tend to be more like ECG graphs in the short run while behaving like weighing scales in the long run. No one can actually predict what is going to happen in the short run but we mostly have a fair idea of where the markets are headed over long run. The short run for equity markets can be described as anything less than say 1 to 3 years of time, it can be days or months together. The long run will be say over 3 to 5 years. The longer the period, the better can be the predictability of growth trends and markets. A real problem arises when we observe sharp market behaviour in relatively shorter period of time, stroking the emotions within us. As market moves up and down, the emotions within us change. The worrying part is that these emotions are the opposite to what rational logic would suggest at different peaks & bottoms of the market cycles. Have a proper look at the image below which shows how the emotions of an average investor plays out in response to market movements.
THE UP JOURNEY :
At the time of beginning our investments, we feel optimistic about the future and decide to invest for the long run. Slowly, we as see the markets rising, we are more excited and thrilled. At this time we often also invest more money hoping the trend will continue. When it does, we feel euphoric as if we have really achieved something.
THE DOWN JOURNEY :
However, as the market cycle reverses,we at first are a little worried but we assure ourselves that the trend will be temporary. When it falls further, we deny any down cycle but we begin worrying about investments while continuing to hold them as long-term investors. Slowly, as market falls, we start fearing and then end up panicking when our profits have wiped out and investments are at big loss. We keep hearing and accumulating all the negative news around us and we feel the decision to invest was wrong and it would be now wise to stop our losses by selling – just like everyone else. When the markets reach the bottom, we fell we have made the right decision.
THE RISE AGAIN:
Slowly rationality and logic sets in and there is reversal of the trend after the bottom has been hit. We feel a bit disappointed as the market rises above the levels we have sold. Uncertain of the market direction, we decide to wait and watch. Slowly, as markets rise, our sentiments change from doubt to hope to optimism. After markets have risen well, we feel confident again in future to enter markets. We take our past experience as a lesson in investing and then invest again for long-term. Waiting for the history to repeat itself.
SAYING NO :
What we have learnt from history is that people do not learn from history. The saga of market cycles and emotions continues to play every time and the same herd behavior is often seen in the markets. Investors often jump into investing after seeing very attractive returns already made by others who invested much earlier. And when there is a fall, most are not matured and patient enough to see notional losses in their portfolio and react by selling.
Time in the markets rather than timing is what really matters in the markets if we want to make big returns. But to do this successfully, we have to control our emotions. Most of us are intelligent enough to make right investment decisions but do not have the temperament to carry it through. Dravid, perhaps the greatest middle over batsman from India, was able to survive the most challenging oppositions in foreign soils more because of his steady mind. He did not allow himself to get carried away even after tough sessions of low scoring or falling wickets. He is today remembered for that temperament and discipline.
THE KEY :
The secret of success in investing is known to everyone but practiced rarely. It is about being rational and logical when others are being emotional. It is about avoiding hear behavior by investing when others are selling and being grounded and rational when others are euphoric. Let us remember this simple behavioral aspect of investing and we will be good enough for being successful than a big majority of other impatient investors in the market. Let us hold steady and stay on the crease for long.
 |
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful
– Warren Buffett |