Many people consider the stock market to be an unpredictable area. However, if someone makes an effort to try to understand it, he can put his hands on a great treasure – and I am not necessarily referring only to a growing portfolio. Observing investor behavior and understanding the psychological factors that move prices can provide us with such an enlightening experience. We can then take those lessons and apply them in our everyday lives in order to be more successful and happier, and to result in better decisions made at work and in our personal lives.
From time to time, we may witness bouts of irrational decision-making on the stock market, which over time adjust and return to reality. On many occasions, investors will panic as a consequence of company results that disappoint, sending valuations lower on the assumption that the company will never again be the same. Then, once a few quarters have passed and it becomes obvious that the earlier poor results were only temporary, that management is back in control of the situation, valuations will begin to rise. (In the meantime, while the panicking investor is selling, the cool-headed buyer is making gains.) The given reaction had been emotional, rather than logical, and had projected the current situation onto the long-term future.
Does this situation sound familiar? After going through a disappointing period in our lives, our emotional self-assessment goes through something similar, but having a familiarity with the psychological background, we can more easily return to firmer ground and restore our self-confidence. Of course the process can work in the other direction as well. With one or two outstanding quarters that blow away analysts’ expectations, Apple stock goes through the roof. With one or two quarters of dominating performance at the workplace, all of a sudden we think we are ready to move into the CEO’s office. Of course this situation is fraught with danger, for he who believes himself to be on top of the mountain soon finds himself heading down…
We can also often observe on the stock market another phenomenon, which is prevalent in workplace and personal decisions. This is the “herd mentality”, which can be defined as individuals adopting the majority’s opinions and behaviors. The psychological explanation in this example is motivated by a need for security. On the stock market this can lead to bubbles, whose destructive powers are unavoidable whenever they pop. The 2008 market crash in the United States was caused by such a bubble. The thinking went thus: “If my neighbor takes on a mortgage, then surely it will be a good decision if I do the same.” He who can remain sober and think independently when all those around him are losing their heads has a greater chance to make good decisions.
The stock market over the past several decades has also shown that the most important fundamental in the lifecycle of any company or country is trust. The source of trust is faith – the belief that what we see, think or feel is real. In mid-2008 everyone believed as an article of faith that the American banking system was stable. Then in the span of a few months, that faith was gone, and the banking system lay in ruins. Trust is the key issue in our lives. If we invest time and energy into our families, friendships and work relationships; building and maintaining trust will play an ever greater role, and positively affect our current quality of life, as well as our future possibilities. The company wherein the relationships among the owner, the management and the employees are built on a foundation of trust will obviously be a more successful one.
However, acquiring knowledge has a price. Investors do not automatically have these skills, but finally grasp them after constantly, often, and ruthlessly challenging their investment decisions. The process often manifests itself in the form of a steep learning curve, which the majority never surmounts in the end.
Let’s try to imagine a more abstract situation! We are all investors, and our investment is nothing less than our futures and those of our families. If we can understand the emotional reactions and the contradictory background of logical decision-making that appear on the stock market, and if we can stay calm in critical situations, we have a great chance to see our noblest stock’s price go higher and higher.
Written by Socrates – Original date of Hungarian publication: Friday March 7th, 2014, in Alapblog