Wednesday, 20 June 2012

Investing Psychology: Market direction and confidence.

For some time now I have been trying to understand how outside factors affect markets, share prices and company valuations. In particular where news-flow, rumours, and speculation are concerned, in order to filter out the noise, if indeed that is what it is.
I would also like to understand if/how my emotions are affecting my investment decisions which is very much a case of "Investor know thyself".

So what is it that happens to our inner confidence and conviction when markets change dir
ection, up or down.
Funny that when markets are going up many investors have a very emboldened laid-back attitude towards associated risk and often invest for fear of missing the boat and failing to make some apparently easy money.
But the fact is that many investors seem unable to see beyond whatever direction markets seem to be moving in and, therefore, can only see one projected outcome.
In general this is a straight forward projection that markets will continue in their current direction, which is illogical.
This even seems to hold true on the shortest of timescales as can be seen when markets surge in a day only to dissipate the next.
We might talk about accepting and understanding volatility but it still seems all too easy to become fixated on whatever the consensus is at the time.

What a neck snapping correction to our confidence it is when markets change direction, particularly when turning down.
Suddenly there is danger in every shadow, every fear is amplified, and yet again we can only foresee one direction, in this case disaster, and anticipate that markets will continue to fall, which forces us to hold our hand and fail to invest, or sell out.
It is for fear of losing money this time but having bought at the top, many now sell at the bottom.
On the one hand it seems to be greed and a fear of missing out on one hand but on the other, it is fear of losing "everything".
But this fear of losing can also bring a paralysis as in our "new" projection we can't see how far markets will fall.

In both cases I often think that there is an added peer pressure element. An "I told you so" that comes with being wrong in both directions: failing to invest as markets continue to rise and losing money when markets fall.
Strangely enough this goes hand in hand with comments like: "its easy money" when markets are rising but; when falling, stock and shares are "far too risky" and you will "lose the shirt off your back".
A sudden short term move against our conviction often acts as an immediate confirmation that these statements are truths to be followed by an "I told you so".
This potentially embarrassing "I told you so" might also be from an inner voice where we almost want to feed our fear and confirm that we are correct.

But, barring the worst case scenario and depending upon your horizons the fear of a "temporary" dip below your purchase price shouldn't sway you from a long term investment decision unless you feel that the investment's fundamentals and prospects have been permanently damaged by external events.

So what is it that turns "cautious repositioning" into feelings of conspiracy and allows us to exaggerate a retreat into the very beginnings of a rout.

I would suggest that market maker discounting can cause emotions and doubt but is driven by a different set of objectives i.e. to manage working capital, exposure, and liquidity (buyers and sellers), rather than any immediate changes to company fundamentals and prospects.
They in turn are managing a business and as such, have a limited amount of capital, and can't buy (or sell) every share of a company that is on their register.
They also need to encourage liquidity as (I assume), they make their money on the margin, or spread.
As such any discounting should just be a temporary.

I would further suggest that it is really about testing your own judgement, valuations and mettle. In other words you are trying to find the strategy that works for you and increases your probability of success.
There will always be pitfalls, and "emperor's new clothes" out there to catch you out and tempt you (learning opportunities!), but if you can bring the probability of success more towards you, such as being ahead in 7/8 out of 10 investments then you have a confidence building foundation to build from.
For every super-duper, pharma-technology, next big thing out there, there are more than few re-labelled snake oil bottlers to try to take us for all we have.

Success can be as much about the shares you don't pick as the ones you do.
Patience is a virtue after all, and a clear strategy will help you to achieve this.

The macro-economic and political shenanigans that play to our fears are often just that, shenanigans.
In most cases these external influences persuade markets to apply discounts and premiums to share prices that, because of the horizons, are often at odds with the true prospects and worth of a company over a different horizon.

On the face of it then, a different horizon, can often put them at odds with our chosen strategy.

I have had a few goes at trying to write this post and, having watched England's progress through the group stages of the European Championships, saw a number of comparisons that brought it back into focus.
As background, despite the pre-tournament problems with managers, players etc. there will always be an expectation for the England team to do well.
But because of the well publicised issues this time around, this was hugely downplayed with every segment of media coverage beginning with the "lowest level of expectation to ever accompany an England side into a tournament".
Some had even gone so far as to suggest the worst prepared England side ever but I would dispute that having watched England lose to Croatia in a world cup qualifier and then their performances in South Africa.
This media influenced sentiment eventually being mirrored in every supporter, and underlined by years of being disappointed ("much too risky" and "I told you so").

However, now that the team have come through the group stage unbeaten you can immediately see the change in the flavour of media coverage to the point where we should now be confident of England's prospects and that they can go on to win despite Italy, Spain et al ("easy money" and "I told you so").
Its not to say that they can't improve, progress and win, but it serves to illustrate the role of the media in stoking fear and emotion up by telling us what we want to hear and achieving their objective of "selling" news.
Fair to say that the Media industry is only human though and therefore, Media neutrality only exists as far as it aligns with personal objectives. We can only hope and trust that we are aware of this when listening.

So back to reflecting on the the market's current woes, it really does go against every study of successful investors who make their consistent gains from buying against the tide of opinion when fear is stalking the markets with heavy, ominous footsteps.
It is also where most would be investors go wrong, investing at a peak (albeit short term) then often being driven to sell (at a loss!) when markets slam into reverse burdened by the weight of media headlines and analysts looking to make reputations from an scatter gun, eventually right soap box opinion.

The reality is that, with homework backed conviction and a clear strategy, we should be doing the opposite.
And then, even if we don't catch the bottom, if we are buying the right shares then time will eventually enable quality to win out.
If identified investments had attractive valuations and prospects up until recently then you could possibly be getting them with an additional discount of another years growth for free when markets get fed up off the pantomime playing out across Europe.

And, as potentially disastrous as they tell us Europe could be, I am certain that if it wasn't Europe it would be something else that would be stoked up to heightened levels of news worthiness.

Anyway, it helps to write it down, and I genuinely feel that it is normal human nature to experience these emotions.
And, time will tell if I have the right strategy and timescale, and know myself well enough to override any irrational fear that might throw me off course.

Wish me luck.

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