Do not panic; learn the psychology

To be a successful investor, you really need to understand psychology as well as history and philosophy.  Very often emotions drive the market up or down.  Remember that economies and stock markets are two different things.  

As Paul Samuelson,l the Nobel Prize winning economists, once put it, "The stock market has anticipated nine of the last five recessions."

China's economy, for example, has been growing rapidly for years now, yet its stock market declined consistently for four years between 2001 and 2005.  The public overreacting to positive or negative news reports, will buy or sell short at the wrong time.  Investor psychology can accelerate such trends int he market.

Anybody can feel panicky.  Losing your perspective in the midst of market panic is equivalent to losing your money in that market.


Ref:

Jim Rogers
A Gift to My Children

Why Selling feels Uncomfortable?

Selling requires of us a significant change in our thinking - indeed a complete reversal! 

When we bought that stock, its prospects were wonderful, and it represented value and opportunity.  Now, whether our investment has since done well or not, to sell requires closing down hope and perhaps admitting defeat.  And it is possible that our defeat may have been created by faulty initial thinking, meaning we can place no blame externally since we were actually wrong all along.  Not a realiszation we savour.

Buying involves the opening o f possibilities of great things.  Buying represents open-endedness; continued holding maintains such hope for gain and pleasure (or, when we have a paper loss, hope for recovery and the righting of a temporary wrong).  Selling carries a finality with it because, by definition, it closes the book or ends the game and establishes a final score.  We prefer to have our options open rather than foreclosed, to retain chances for improvement and betterment rather than to know that the verdict is sealed and no chance for change exists.  We have great difficulty coming to closure since it cuts off further possibiiities; it ends hope for any better outcome.  Closure includes such experiences as

• cleaning out great grandmother's attic;
• graduating and leaving school and friends;
• acknowledging a failed marriage by concluding a divorce;
• burying a dear friend or loved one;
• seeing winter come;
• leaving an employer and valued colleagues;
• retiring and therefore wrapping up business. 

Those are heavy and sad passages, so we are predisposed to resist voluntarily creating any closure expereinces that we have power to avoid.  Holding does exactly that.

Holding keeps our options open, while selling clearly brings closure and finality.  (With surprising myopia, we ignore the fact that once we sell a stock we can just as easily repurchase it.  Viewing repurchase as a very real antidote to our revulsion against closure, however, raise visions of again going through that agonising process of reversing our opinion by 180 degrees, which is painful for all the reasons noted above.) 

• So we hold rather than sell because, at the very least, holding postpones coming to closure. 
• Many a bad stock is held (into an uncertain yet not hopeless future) with palpable likelihood of further financial loss because the (presently avoidable) emotional cost of coming to closure is perceived as so heavy. 
• Investors pay in dollar losses to avoid emotional pain from a closure process; often, as losses get worse, they will later need to pay a higher price in both lost dollars and eventual pain by imposing self-punishement over major mistakes. 

The closure aspect of selling is a powerful deterrent, one requiring both strong will and courage to overcome.

Why Holding Feels Right - Understanding the Psychology underlying this

Understanding the subtle but strong psychological impediments against selling

At a most obvious level, making profit represents pleasure, while suffering a loss equates to feeling pain.

Let us attempt to understand the deeper layer of forces that dispose us to certain attitudes and behaviours springing from our subconscious pain-avoidance and comfort-seeking tendencies.

When we own a particular stock, inaction (holding) keeps us in or certainly closer to a place of comfort than does taking action to change our circumstances (selling).  Holding onto a friend keeps us close to our past, to memories and feelings we cherish.  Many continue to hold stock in companies whose fortunes peaked years or even decades ago.  Logic alone cannot seem to explain why they resist selling despite obviously dim prospects for recovery or gain. 

• Maybe grandfather worked for the company, or we reside in a town where it supported many families or sponsored the softball team. 
• Perhaps ages ago we made a profit, or at least had a good paper profit for a while in this stock. 
• Or our parents always spoke well of the company or
• confided they had made a decent sum in its shares at one time. 

Thus, nostalgic positive feelings surround it and we find it very difficult to end our association.

Our positive associations with a particular stock create a bonded feeling. 

• We have made a good profit on an overall basis and while the annualised return may be unspectacular, a gain is surely better than a loss and the total dollar or point profit feels pleasant.  So this stock is our friend. 
• Held for a number of years now, it has been virtually adopted as a family member.  Thus, our primary inclination is to not severe such ties by terminating this comfortable relationship. 

Why end this thing, we think at an unconscious and perhaps also at a conscious level.  Living with, rather than without, that stock represents staying in a comfort zone.

Even though the company's fortunes may now have faltered, choosing to sell its stock represents adopting a 180-degree opposite stance.  Issuing that order to liquidate means that we once thought was correct now is no longer so in our minds. 

• This company is no longer under priced, or its prospects or management quality are not what we earlier imagined or expected. 
• Or perhaps we have given up on its price/earnings ratio growing as we had earlier envisioned.

To say sell means that either

• what we once thought was right is no longer so and/or
• that maybe we have already been on the wrong side of the market for some time and are now admitting a change in opinion is warranted. 

Either way, selling represents admitting we now believe what we earlier thought is no longer true.  Most of us have great difficulty acknowledging that we were wrong. 

If you place a very strong value on reputation or esteem in life, the reversal of position inherent in selling is likely to be an especially difficult battle zone for your ego and your comfort.  This can be a special problem for professionals such as doctors, attorneys, and others looked up to.  Reversing a position is made even more difficult if we have publicly or strongly espoused it.  This is a very important reason for keeping our investment holdings secret:  reversing ourselves and selling then at least involves no loss of face with others who knew our prior opinion.