A popular mantra of the stock market is “buy low, sell high”. However, when push comes to shove, this strategy is hard to follow. Investors in general are irrational and are driven by their emotions and biases.
Due to the uncertainty in the markets, there is a general belief that markets will keep plummeting and vice versa when markets are rising, reflecting the market psychology. This generally happens when investors fall victim to their own emotions.
“Financial markets are driven by two powerful emotions, greed and fear,” goes an old proverb. These feelings are so powerful that they can damage not just your personal life but also your financial situation and the process of accumulating riches. These feelings, in addition to prejudices and hearsay, are what lead to market bubbles and subsequent corrections. This is known as the fear and greed cycle in technical terminology. The wealthiest investors are those who can maintain composure under pressure and act sensibly even when the market acts foolishly. Let’s examine the impact of these feelings on investing choices.
The Power of Greed
In the materialistic society of today, everyone aspires to be wealthy and wants to become wealthy more quickly. People are motivated by greed when markets are rising. Anxious to make as much money as possible as soon as possible, investors become envious of rising prices, which indicate bigger returns. Prices rise to outrageous heights as more and more individuals invest as profits increase. Bubbles form in the market after it reaches these extremely high levels, signifying high market values relative to fundamental values. The bubble eventually pops, leaving investors with losses.
For example, prior to the Great Financial Crisis of 2008–2009, the United States experienced a housing bubble, in which home prices rose to unprecedented heights but the real worth of the homes was significantly lower. As a result, the bubble popped, resulting in a recession and the loss of many people’s houses.
In order to prevent losses in these situations, extreme self-control is needed over emotions like “herd behavior,” “fear of missing out,” and greed. Anyone who wishes to invest sensibly should practice the basic fundamentals of investing. These consist of maintaining a long-term perspective and, on the recommendation of a certified mutual fund distributor, resetting the intended asset allocation.
The Impact of Fear
One may argue that fear and greed are two sides of the same coin. Fear can have a significant impact on the market in a manner similar to how greed can dominate it. When the markets decline sharply, fear is evident in the market. There is a generalized panic in the market when the markets begin to decline. The investors liquidate their holdings to reduce their losses as a result of this panic. They are unaware, though, that the loss does not become apparent until the investment is sold.
For example, you paid Rs 100 at NAV for ten units of a mutual fund. The value increased to Rs 120 as a result of the market’s avarice and overconfidence. At this moment, the investor’s greed takes over and they want to purchase further units. But the unit price falls to Rs 90 in the next several months. This type of loss is known as a notional loss, and it doesn’t become an actual loss until the sale is decided upon. The investor books a loss in an attempt to stop losing money. A sense of remorse for incurring a loss sets in after a few months when the prices begin to return to average.
Riding the Cycle of Fear and Greed
Benjamin Graham once said, “Those who can’t control their emotions aren’t the best people to invest for.” The stock market’s volatility is symbolized by the concepts of greed and fear. Investors are uncomfortable with these cycles of notional losses and market volatility. As a result, they give in to their feelings and suffer severe losses.
There are certain things we cannot control. You have no influence over the market, any more than you have over the acts of others. Your behaviors, though, are within your control. Whether or not your emotions control you and your behavior is something you can manage. Moreover, the decisions you make in the market will determine whether you make gains or loses. You would be better off not caving in to the sentiment of the prevailing market. It will also represent your irrationality.
One of the hardest things to do is to control your emotions. Differentiating oneself in decision-making is much easier stated than done.
Here are a few tips that can help you refrain from the influence of the dominant market sentiment and make wise decisions.
Create a Plan
Establishing a clear investing strategy is necessary before beginning any kind of investment. Your financial requirements, risk tolerance, and appetite are all thoroughly examined. It’s crucial to follow the plan after it has been developed and resist giving in to feelings. Leaving your plan early might have negative effects on your portfolio and lower returns, regardless of how the market is feeling. When these preparations aren’t in place, impulsive decisions are made and fear and greed take over. Making the most of your investment will require you to do nothing in spite of the increase and fall in your investments other than adjusting the asset allocation in accordance with the mutual fund distributor’s guidance.
Invest in Long run
Mutual funds are a fantastic tool for maximizing wealth, but this is something that can only be done over time. It is dangerous to have the mindset that investing in the markets can make you wealthy soon, and you should avoid falling into such scams. You should invest gradually over the long term rather than rashly based on your emotions if you are willing to expand your fortune. Trying to get “stock market tips” or guessing the next “multibagger stock” to make quick money is a big mistake that might wipe out all of your hard-earned money invested in the market. Taking on additional risk in order to attempt to profit from trading or riskier investing channels like futures and options can be Harmful.
Check out portfolio
It is crucial for you to monitor your investment portfolio as a knowledgeable investor. It is essential to regularly analyze your portfolio in order to assess how well your investments are performing in relation to your needs. It’s not necessary to monitor your portfolio every day, but it’s a good idea to do so on a regular basis—for example, every quarter or during periods of really strong market volatility. You now have the chance to examine how well your portfolio fits your risk tolerance. Additionally, one can make analytical choices free from emotional bias, such as deciding whether to rebalance the portfolio.
Enhancing Knowledge
The process of learning never ends. Gaining some understanding of financial options, such as mutual funds, can be quite beneficial. A mutual fund distributor can provide assistance as it might be challenging to stay current on all of the investment options. Acquiring knowledge of the technical terms might simplify your comprehension of the most recent advancements in the economy. It can be very beneficial to learn from the mistakes made by others, like as the dotcom bubble and the Great Financial Depression of 2008–2009, as well as from the experiences of the greatest, such as Warren Buffet. Refreshing your memory can also assist you in spotting market rumors and preventing hasty actions based on them. Above all, as you go along your financial journey, remember your personal experience.
In conclusion, if you allow feelings like greed and fear to influence your decision-making, they could have a significant effect on your investments. You eventually run the danger of making mistakes because of this. It can be hard not to feel these things when making investment selections. However, with knowledge, experience, conviction, and a sound investing plan, you can progressively start molding yourself into the astute investor you want to be.