The overall mood or feeling of a market can catapult entire nations into bull or bear markets. Bears and bulls are used to describe markets by comparing their “methods of attack” to the trend, or perceive trend, of the market. Just as bears swing their paws downwards, a bear market describes a market where commodities or securities are dropping in price and the general feeling is these prices will continue to drop. Bulls thrust their horns upwards when attacking. Similarly, a bull market describes a set of securities or commodities which are rising in prices and in most people’s opinion will continue to rise. Either of these markets can be dangerous for investors because they can create artificial feelings of certainty or security that only exist in the investor’s mind (or investors’ collective mind).
In a previous article “Residential Mortgages: Don’t Get Cornered in a Bull Market” we discussed the dangers of getting wrapped in the unrealistic optimism of the moment and investing more than you can afford. The opposite is also true. After a particularly nasty bear market, investors may become overly conservative due to the fear of further financial losses. How can you tell if you have been hit by bull’s market blues? If any of the following statements match your “feeling” for the market, you may have reasons to increase your risk tolerance.
“I actually made a profit on those stocks, so I sold them”
Obviously, there is nothing wrong with selling stocks for a profit, but if you find yourself in the habit of selling anything that provides the most marginal of profits, you may be experiencing what some financial academics call the “disposition effect”. Don’t worry it’s not serious and most investors have it at some time. This effect describe the aversion we all have to losing. Shocking eh! Yep. Apparently investors feel the pain of loss twice as much as the pleasure of victory. This natural tendency can cause investors to become overly shy of risk because of the fear of loss. Some would say this is not a problem and that the world may be a more financially stable place if more bankers suffered from it. However, if as an investor you tend to overestimate the risk of a transaction you are unlikely to make the most of opportunities when they appear.
“This market recovery will not last, the market is growing too fast and will correct itself soon.”
If you hear yourself saying this, you could either be right or be suffering from anchoring. If you don’t have hard data to base your prediction on, you probably are experimenting a mild bout of anchoring or sticky reference point syndrome. This syndrome causes investors to create an imaginary “normal level” or “anchor”, which somehow holds back the prices of stocks and causes them to return to a set position. According to most financial academics and investing professionals financial markets cannot be reliably predicted by price patterns in the past. In other words the past has little if anything to do with the future price of a stock. A nice analogy to allowing past performance to dictate your investments is to try and drive a car by solely looking into the rear view mirror. Yes, in both cases you are likely to crash.
