Monday, 10 March 2008

The Cycle of Market Emotions

Here is a chart that shows the cycle of emotions people go through when investing in the markets (shares or properties). Understanding the cycle and the emotions that go with it can help equip investors to tolerate and benefit from market fluctuations, as we are seeing now in share markets around the world.

The average investor makes decisions that are based on emotions and these decisions are usually opposite to the decisions that should be made. Most investors want to chase the winners or the funds that seem to be doing the best and and when the market is doing poorly the investor wants to sell. If investors left emotions out of the picture they would do far better.

Click image to enlarge

The point of Maximum Financial Opportunity is when the market has dropped by significant amount and seems to be at the bottom. Ideally, this would be the best time to invest in quality shares at cheap prices. However by this stage, most investors are deeply paralysed by fear of a further market slump and will do nothing.

On the other hand, the point of Maximum Financial Risk is when the market has had substantial gains or seems to be at the top. Many people are feeling great about their investments at this stage. They feel like they just can't lose in the market, so they add more to their investments and even taking on significant debt. But sooner or later the market will turn and they are in for a roller coaster ride.

Right now I think we are at the Fear or even Desperation stage in the share market. Panic and capitulation and soon follow and then despondency and depression. But take a close look. Even though investors may be saying to themselves "maybe the markets just aren't for me" we are not far from the point of maximum financial opportunity.

The key to feeling secure in a market like this is to know that it is cyclical in nature and to understand the normal feelings which accompany a down market. Don't panic and run for safety. Think through your investments objectively and avoid debts. Around now is a good time to buy shares in quality companies.


Happy Face said...

Interesting article =)