As an experienced investor, I can admit that I have been affected by fear and greed, two of the biggest psychological effects of investing. And both effects kick in the most during volatile markets. It is horrifying to think that one’s convictions can change so quickly, but this is a psychological effect that is very hard to ignore. Here are our thoughts on what happends during volatile markets and why these feelings affect our investing.
Volatility Causes Market Fear to Rise
When the markets panic, fear sets in. Market selloffs, especially sharp and dramatic ones, cause investors to doubt their convictions. What seemed like a good investment the day before can suddenly scare you into selling. Even experienced investors feel this. I’ve realized that my brain works on a black and white basis. Even though I know that life is mostly gray areas, I often view the market as either a good investment or bad investment. I watch economic indicators, look for improvements in the underlying fundamentals, and then wait for the selling to subside. When the market starts to ignore negative news and move up regardless, I decide its time to buy. This is a conviction that I make. I must either feel that its a good time to buy, or I stay on the sidelines waiting, but not wanting to miss out on any rally. Then, in moves fear.
Even though the conviction seems strong at the time. A few weeks of big selloffs and one really starts to doubt their investing choices. This leads to fear. Not just the fear that your conviction was wrong, but the fear based on watching other investors. Even if nothing has changed fundamentally in the economy and stock market, if other investors panic and keep selling, the question arises of whether or not they are going to keep selling. Even if you think you’ve made the right choice for the long term, the fear sets in because you don’t know when other investors are going to stop selling. The fear feeds on itself, especially during slow economic times. The less conviction their is in the market, the more fear and volatility rise.
Unfortunately, these are the best times to invest because they offer the greatest rewards when the selloff stops and the rally begins. Missing just the first week of a significant rally can set you back by a full year’s return. It is this fear that causes us to make irrational decisons which we later regret.
Rising Markets Cause Greed
When volatility subsides and market start climbing steadily, a new emotion takes over – Greed. As markets climb, a few factors come into play. First, many investors see the returns they missed by not investing during the fear times, and want to make those returns back. This is a common trait of fear in investing. The second thing investors do during rising markets is that they forget about the bad times. When good news and rising markets continue, investors become overconfident and often assume that good times will keep continuing. For that reason, they get greedy and start investing in more and more questionable investments that offer the returns that they’ve come to expect.
Another factor to consider when it comes to investing is how people react to market gains and losses. Psychologically, people take losses much harder than gains. For proof of this, just listen to what investors are talking about in the break room. When the market’s gone up 25% in a year, people are talking about how well they’ve done and all the right choices they’ve made. Now, when the market goes down 20% in a year, what do you hear? The same people talking about how the economy, or the President, or some other country caused their investments to decline. In other words, they credit their gains to themselves and blame their losses on other people. Add to this that people feel good about their gains but the feeling often leads them to ask questions such as “Why didn’t I make more?”. This is a typical greed phenomenon. When people lose money, many investors can’t even sleep at night because of the extreme negative effect. It all boils down to the fact that losses are much harder to take than gains. Because people like gains but hate losses, their minds are constantly rotating between fear and greed.
How to Balance Your Investing Between Fear and Greed
If you are succumbing to some of these investing emotions, don’t worry. There are ways to deal with them. Start by using these tips to help you balance your investing choices between fear and greed.
- Pick investments that you believe in for the long term. You will be much more likely to sell stocks that you do not truly believe in during volatile markets. Stick with companies that have long track records and that you are comfortable with.
- Don’t watch day to day swings. Once you’ve made your investments, don’t check their prices too often. Don’t look at stock prices while the market is open. Check at the end of the day when it is too late to do anything irrational. Better yet, only check stock prices every week or even every month. If you’re a long term investor than a few weeks or months won’t matter.
- Think long term. Don’t buy stocks because you think they are due for a run. Buy stocks you believe are in for long term growth and then hold onto them for a long time. Also, don’t make sell decisions based on a few days or even a few weeks of trading activity. The stock market moves around a lot and it is best to ignore short term fluctuations.
- Don’t make decisions based solely on emotions. If you are angry don’t sell, if you are happy, don’t buy. Don’t let market movements make your emotions so powerful that you make irrational decisions. Talk any purchases or sales over with a friend or spouse before you make any investing decisions. You will likely clarify your position to yourself, as well as test the validity of your plan.
Fear and greed will always drive the stock market and influence the way investors react to market volatility. There’s no getting around this fact, so take these factors into account before you start using your emotions to make your investing decisions.