Tristan de Gouvion Saint Cyr quotes Wikipedia about a phenomenon that plays an important part in trading, called
behavioral finance.
This field studies the effects
of social, cognitive, and emotional factors on the economic decisions of
individuals and institutions and the consequences for market prices, returns,
and the resource allocation.
The fields are primarily concerned with the bounds of rationality of economic agents. Behavioral models typically
integrate insights from psychology with neo-classical economic theory.
Tristan de Gouvion Saint Cyr gives
this video from Investpodia to illustrate the point:
As the
pendulum swings between greed and fear, investors typically become
over-enthusiastic during bull markets and over-despondent as the bear’s growl
grows louder.
It stands
to reason that in order to be a successful investor, it is important to
distance yourself from the herd mentality and to take objective decisions based
on fundamental reasons.
The
typical behavior of investors is linked to the so-called investor psychology
cycle (courtesy RMB Unit Trusts), as illustrated below.
Before
seeking to apply the cycle to the present stock market situation, let’s
consider a short definition of each of the stages.
Contempt: According to the cycle, a bull market typically starts
when a market is at a low and investors scorn stocks.
Doubt
and suspicion: They try to decide whether what
they have left should be invested in a safe haven such as a money market fund.
They have burnt their fingers with stocks and vow never to invest again.
Caution: The market then gradually starts showing signs of
recovery. Most investors remain cautious, but prudent investors are already
drooling at the possibility of profit.
Confidence: As stock prices rise, investors’ feeling of mistrust
changes to confidence and ultimately to enthusiasm. Most investors start buying
their stocks at this stage.
Enthusiasm: During the enthusiasm stage, prudent investors are already
starting to take profits and get out of the stock market, because they realize
that the bull market is coming to an end.
Greed
and conviction: Investors’ enthusiasm is followed
by greed, which is often accompanied by numerous IPOs on the stock market.
Indifference: Investors look beyond sustainability high price-earnings
ratios.
Dismissal: As the market declines, investors show a lack or interest
that quickly turns to dismissal.
Denial: Then they reach the denial stage where they regularly
affirm their belief that the market definitely cannot fall any further.
Fear,
panic and contempt: Concern starts to take a hold and
fear, panic and despair soon follow. Investors again start scorning the market
and once again they vow never to invest in stocks again.
In order
to determine where in the stock market cycle we find ourselves, the challenge
is to identify the prevalent stage of the psychological cycle. I would, for
starters, argue that we are on the right-hand side of the curve, but how far
down the slippery slope sentiment has declined is less clear. It would seem
that we are possibly in the region of the “denial”/“fear”/“panic” phases.
Although enduring investor panic and fear have not really set in, the January,
March and July sell-offs did witness climatic, albeit short-lived, bouts of
despair.
Time will
tell whether we are dealing with a typical investor psychology cycle and how it
will play itself out. It does, however, seem that we are at not at the
“contempt” stage yet, i.e. when investors scorn shares en masse and a bull
market typically starts.
Realizing
this mental process is the first step towards becoming a smarter, more rational
investor.
Tristan de Gouvion Saint Cyr is an investment professional specializing in investment strategies for HNWI, ranging from vanilla products in various asset classes to sophisticated structured set-ups. Tristan de Gouvion Saint Cyr collaborates with investment bankers, asset managers, stockbrokers, life assurance companies and charities to create custom-tailored solutions
No comments:
Post a Comment