Wednesday, 7 March 2007

The Emotional Share Market

Yesterday, John Kay, the author of the Truth about Markets (which I highly recommend to everyone – one of the better books I have read for a long time) wrote a short piece on the Financial Times, on the current share market correction and its… erm, psychological effect on normal investors. Very fun and insightful. Go and read it.

Watching Share Market will Not Make you Happy

By John Kay

…(B)ut the paradox is that if you do not have complete control over your emotions, you can have too much information for your own good. Many investors have just spent a nervous weekend. But someone who fell asleep over Christmas lunch and woke for St Patrick’s Day would be entirely relaxed: his portfolio would have barely changed in value.

Nassim Nicholas Taleb, the trader and author, illustrates the curse of knowledge with the example of the investor – call him Warren Buffett – who substantially outperforms the market over the long term. If Warren looks at his portfolio only every five years, the results will almost always be encouraging. If he reviews his investments annually, he will have observed more good years than bad ones. But even a successful investor who looks at his portfolio every day can easily become depressed. Fifty one per cent good days and 49 per cent bad days will produce a good result, just as someone whose coin tosses work out 51 per cent of the time will become extremely rich. But it may not feel like that.

For those who follow events too closely, the pain of regret can far outweigh the joys of success. Life, and markets, contain so many missed opportunities…

Accept that most market movements are statistical noise that convey no information about the past and provide no guidance about the future…

Monitoring your portfolio every day will impose a high emotional cost for negligible financial benefit… (M)any investors will have concluded that the current turmoil makes it vital to be close to the market. The opposite conclusion is true.


On the same topic, this is by Henry Blodget from, in his latest piece on his Bad Advice series, aptly titled “The Market's Crashing! What Should You Do Now? Um, nothing”. Hehe. Go read it too.

It started with:

Last week's mini-plunge produced the expected blizzard of stories on the theme: "The Market's Crashing! What Should You Do Now???" The implication, of course, is that smart investors should pay close attention to what the market is doing and adjust their strategies accordingly. Nothing could be further from the truth.

And went on to give four cliché, but useful to remember advices:

  • No one but Nostradamus knows what the market is going to do. Last week's sell-off does not make it any more or less likely that the market is going to go up or down this week (or, for that matter, this year).

  • No one but Nostradamus can time the market consistently. If you knew the market was going to crash, the answer to "What should you do now?" would be obvious: Short the world. Alas, numerous academic studies have shown that successful market-timers are, at best, an extremely rare breed.

  • If it really matters to you what the market does in the next several months or years, you shouldn't own stocks. Sorry to alarm you, but stocks are a very risky investment over periods of less than five to 10 years, no matter what the market is doing. If you need your money before then, you shouldn't have it in stocks.

  • The last thing you should base your investment strategy on is what the market has done. One of the most common and most devastating mistakes investors make is "driving with the rearview mirror," as Warren Buffett puts it. Specifically, they buy investments that have done well and sell those that have done badly. Although this strategy feels comfortable, it is idiotic.

Dum dee dum,


(emphases and underlines all by me)


Anonymous said...

There are just too much hazards and pitfalls of investing in the stock market from the stories we hear.

To be successful in stock market investment they always tell us to take advantage of the weak market to collect low and sell high on an uptrend.

But how many of the public can have the means to behave like the Big Boys who do just that ?

which shares to buy ?
when to buy ?
when to sell ?
buy low sell high ?
buy high sell higher ?

Emotional ?
Complicating I would say..


Dek Mat said...

feliz: you are missing the point of this article. if you are in the stock market to speculate then you have to accept the high risks as well.

The article is trying to say to think about "which shares to buy? when to buy ? when to sell ? buy low sell high ? buy high sell higher ?" everyday can be very emotionally distressing.

Very emotionally distressing over nothing in fact.

So how to invest? Many strategies to this but the main advice of this article is to buy and then loo at your portfolio again after 5 years.

Elanor, another great post. Damnit if DAP has Tony Pua, SiPM would like to have Elanor Tan! ;)

But let's see if we can agree on economic policies. Have been a bad boy so will post later!

penang boy said...

Investment is a tricky business. There are risky investments which yields higher returns and there are risk-free investments which yields near zero returns. To determine the type of investor you are you should ask yourself if you have the stomach and the financial muscle for risky investments.

While there are many investment theories that one can read up, there is one important lesson that one must not forget - do not let emotions cloud your judgement (Mr Kay is right about this!). Of course, it is almost quite impossible to detach one's feelings when the market plunges 50 points. But, fear clouds your judgment and fear (or even greed) results in the irrational and herding behaviour. Everyone rushes out as they believe that the last one out will get his pants burn.

While investors should take a fundamental view of the market, and ignore cyclical movements (as advocated by Mr Kay), we cannot afford to do so for markets which 90% of the time do not trade on fundamentals.

So, can I afford to sleep thru' Christmas and wake up after the New Year? No, in spite of Mr Kay showning that value of my hypothetical portfolio remaining intact after Christmas. Similarly, if I were to be a long term investor, should I be happy if my portfolio remained as it were 2 years ago? When this happens, it would mean that I have not been compensated for the risks that I have taken. So,I would have been better off keeping my money in risk free asset. In other words (going back to Mr Kay's example), if I had kept my money in the bank I would have gotten some return (minuscule but it beats zero returns) between Christmas and New Year.

Another example will be the 1997/98 stock market crash. The KLCI has just reached pre-Crisis level. It has been 10 years since the CI reached above the 1000 mark. If you are happy that your stock has finally reached the pre Crisis levels and you pat yourself on the back, I will advice that you leave your money to the professionals. Or rather, just be a passive and safe investor and park your money in the bank. Investors who made money are the ones who rode with the volatility, buying when there are dips and selling when the market rebounds.

It is very easy to preach investment theory but as we all know in practice, nothing follows text book theories. No one can time the market. And also, greed always clouds one's judgement. But, I do agree with Mr Kay on one point - never get sentimental with the stock market.