Monday, 1 February 2010

How does investor psychology affect timing?

Investors are inclined to become over-enthusiastic during a bullish phase on the stock market and to become despondent when the market declines.

In order to be a successful investor, it is important to distance yourself from the herd mentality and to take objective decisions based on fundamental reasons.

The typical behaviour of investors is linked to the so-called psychological cycle of investors (Source:  Adapted from Geld-Rapport, 18 March 2001).


Contempt: According to the cycle, a bull market typically starts when a market is at a low and investors scorn stocks.

Doubt and suspicion: They try to decide whether what they have left should be invested in a safe haven, such as a money market fund. They've burnt their fingers on stocks, and vow never to invest again.

Caution: The market then gradually starts showing signs of recovery. Most remain cautious, but prudent investors are already drooling at the possibility of profit.  Now is the best time to buy shares.

Confidence: As stock prices rise, investors’ feeling of mistrust changes to confidence and ultimately to enthusiasm. Most investors start buying stocks at this stage.

Enthusiasm: During the enthusiasm stage, prudent investors are already starting to take profits and get out of the stock market, because they realize that the bull market is coming to an end.

Greed and conviction: Investors’ enthusiasm is followed by greed - often accompanied by numerous new listings or IPOs on the stock market.

Indifference: Investors look beyond unsustainably high price-earnings ratios.

Dismissal: As the market declines, investors show a lack or interest that quickly turns to dismissal.

Denial: They then reach the denial stage, where they regularly affirm their belief that the market definitely cannot fall any further.

Fear, panic and contempt: Concern starts to take hold; fear, panic and despair soon follow. Investors again start scorning the market. Once again, they vow never to invest in stocks again.




Also Read:
Sentiment curves
http://myinvestingnotes.blogspot.com/2009/05/sentiment-curves.html




1 comment:

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