Tuesday, 17 August 2010

The psychology of stock-market investing

Written by John Mangun
Outside the Box
Business Mirror
http://www.businessmirror.com.ph/index.php?option=com_content&view=article&catid=28:opinion&id=29019:the-psychology-of-stock-market-investing&Itemid=64

For five out of six trading sessions over the last two weeks, the headlines talked about how the stock market had reached its highest level in three years. Then the market turned south and the headlines changed to “Market down on profit-taking.”

While the media are filled with people of good intentions and noble hearts, honestly, you are wasting your time trying to get any worthwhile analysis from those sources. The stock market seems like a simple affair to those outside of the business, and everyone thinks he is an expert on the market. What’s to know and learn about the stock market? It is just some rich people gambling on stocks. Or maybe the market is where people buy at the low and sell when they have made a lot of money or lost a lot of money.

To simplify the stock market either of those ways, is to describe what Manny Pacquiao does as two under-educated muscle men who can’t get a real job so they make money trying to beat each other up.

The better of the stock-market commentators may have even browsed the Internet to learn a little more. Then you read analysis that mentions fear and greed and things like that.

I will not bore you with what the stock market is really all about, since I have done that many times in the past. But let me take you through the psychology of investing that every investor will experience. Perhaps you have already.

You must understand that any time you make a purchase, there are a variety of factors that go into the decision-making process. Ever bought a car? All cars are basically the same in function. You did not walk into the dealership and say, “Here is my check for P1 million. Where is my car?”

I would imagine it probably takes you 20 minutes to buy a shirt or a pair of shoes. Lots of factors and lots of decisions because there are many emotions involved.

Investing in stocks is not about buying. It is about the holding on to your shares. And the emotions and related decisions.

When you buy the car or the shirt, the decisions are over. It is not like you are going to decide two months later that you do not like your shirt, and are going to take it back to Shoemart and say, “I bought this last month for P500, but I do not like it. Here; buy it back from me for P300.”

Likewise, you will not take the car back to the dealer and say, “Hey, everyone thinks this is a great car. I will sell it to you for 20 percent more than I paid for it.”

But that is what being a stock-market investor is like.

In this week’s issue of my Stock-Market Update, I wrote to subscribers that “Honestly, I do not like the market right now for the short term.” How in the world could I say that? Everyone knows how positive I am on the Philippines, the peso and the PSE?!

There are four emotions that the majority of investors will feel at some point (but not at the beginning) during a stock-market rally. These are optimism, excitement, thrill and euphoria (Look at how smart I am!). When we reach the point of euphoria, we have found the Point of Maximum Financial Risk. From there, prices will fall.

Going down, emotions are anxiety denial (“It’s OK. I am a long-term investor”), fear, desperation, panic, capitulation (“How could I have been so wrong?”), and despondency. Now, a stock-market rally will begin with prices going up at this Point of Maximum Financial Opportunity. This is where we were in November 2008.

Every investor knows exactly what he is feeling at any given time. It is deciding on what action makes sense, and then doing something that is the hard part. At the bottom of a market, how can you be feeling “despondency” and yet buy into the market? Most cannot do that. But note this: It is only the losers who held shares too long that are feeling despondent. The smart investors were out long before and are psychologically ready to get back in at the bottom, and that is why they make money and most people do not.

Losing investors always miss the bottom. But as soon as prices rise, they come back, feeling, in turn, depression as they miss the first wave up (November 2008 to May 2009). Then it is hope as they finally buy in, relief as their issues show some profit, and then back to optimism.

The psychology of investors that I have outlined is the big picture of price movement. However, it also applies on a shorter time scale.

On the list of emotions above, “euphoria” is felt at the time of a market high. That is accurate. Nevertheless, another emotion that is ignored by most people who analyze these things is apathy or complacency. During the course of a stock rally (which is what we have right now), investors reach a point when they do not feel any real concern for falling prices.

The market has gone up 15 of the last 18 months. Price have risen 34 of the past 52 weeks. It is easy to be indifferent and satisfied. And that is why I do not like the market for the short term.

If I am right and prices begin to fall, investors will start worrying a little. Remember that market-rally emotion of hope? Hope only comes out of worry and concern. We need a little more concern, which will then get investors to hope prices will go higher in the future, instead of just expecting that stocks will go up. Then prices will go up. And by the way, the market is not down on profit-taking. It is down on because of a lack of buyers feeling some anxiety.



E-mail comments to mangun@gmail.com. PSE stock-market information and technical analysis tools provided by CitisecOnline.com Inc.

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