Attempt to unravel the mysteries of investor behaviour can be a stimulating experience . Countless studies have been done on investor psychology , yet mysteries remain. A field known as “behavioural finance” has evolved over time to offer better understanding on how emotions and cognitive errors influence investors and on the decision making.
The most intriguing behaviour that still eludes “Behavioural Finance” experts is the one that comes in plenty at times of market peaks and bottoms. In big Bull Markets , Investors remain blind to risks while they remain doubly blind to opportunities in big market declines . It is fascinating to observe that investors who were willing to bid any price at peaks are now unwilling to even give a second glance at prices that are 1/4th of their peaks.
What explains this rather irrational behaviour . It goes back to two basic human emotions – greed and fear . It is not so much about lack of awareness of either risk ( in Bull Markets) or opportunities ( in Bear Markets) that is driving this behaviour . If so , what blinds us in these extremes. It is rather our mis-guided confidence ( of course coupled with greed and fear) . We , as humans , overestimate our ability to out-smart the crowd in exit and entry . At the peak of Bull Market , it manifests in the form of false confidence that when the music stops , you can , not only stop dancing , but also can rush to the exit comfortably. But people forget the hangover and gate-crashing effect . This is what happens when everyone in the crowd thinks that he can out-smart the other (bigger fool theory !!). Preciously the same illusion blinds us , but in reverse , at the bottom of the market .
The problem gets further compounded because of the presence of false and misleading sharp corrections in Bull Markets and strong rallies in Bear Markets.
So , why is this strong dose of philosophy being dispensed ? . Being aware of this neural limitations can help in executing one’s investment objectives rationally . Needless to say , it also helps in capitalizing undervalued market opportunities at cloudy times like this without worrying about quotational / notional short-term losses , but keeping an eye on long-term wealth building !!! .
Times are exciting for Value Investors !!!