Psycho… or logical? You can choose your adventure when it comes to investing.
Ruling out emotions, or only bringing your rational mind to the table with making investment decisions, is a bit like shopping for a partner based on a list of requirements. It works great in theory until you find the one ‘that’s meant to be’. Investing is about bringing all of who you are to the markets – ignore who you are emotionally at your peril. Understanding how emotions and psychology drive the masses can also give you an edge.
Today we’re covering the exciting area of psychology and investing with guest Mike Taylor of Pie Funds.
Before we start this two-part recording, let’s clear up a bit of jargon:
Note that most of these definitions can be found on Investopedia.com, a great online resource to break down the jargon:
Fundamental analysis: Fundamental analysis is a method of measuring a security’s intrinsic value by examining related economic and financial factors. From macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management. The goal here is for the investor to have a tool to assess whether a company is over or undervalued.
Technical analysis: Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. It’s all about looking at patterns of price movements, trading signals and various other analytical charting tools to evaluate a security’s strength or weakness.
Bull market: A bull market is the condition of a financial market or a group of securities in which prices are rising or are expected to rise. The term “bull market” is most often used to refer to the stock market but can be applied to anything that’s traded, such as bonds, real estate, currencies and commodities. The term “bull market” is typically reserved for extended periods in which a large portion of security prices are rising. Bull markets tend to last for months or even years. Check out this link to an article that talks about the last 12 bull runs in the stock market – the current bull market in which we are in has lasted almost 124 months – this is the longest in history!
Bear market: A bear market is a condition in which securities prices fall 20% or more from recent highs amid widespread pessimism and negative investor sentiment. Typically, bear markets are associated with declines in an overall market or index, but individual securities or commodities can be considered to be in a bear market if they experience a drop of 20% or more over a sustained time period – typically two months or more.
Share buybacks: A buyback, also known as a share repurchase, is when a company buys its own outstanding shares to reduce the number of shares available on the open market. Companies buy back shares for a number of reasons, such as to increase the value of remaining shares available by reducing the supply or to prevent other shareholders from taking a controlling stake. This is a good one that we’re only briefly touching on today but will no doubt explore more this year.
Melt-up : A melt-up is a dramatic and unexpected improvement in the investment performance of an asset class, driven partly by a stampede of investors who don’t want to miss out on its rise, rather than by fundamental improvements in the economy. Gains that a melt-up create are considered to be unreliable indications of the direction the market is ultimately headed. Melt ups often precede melt-downs.
Now two parts of mind we should really talk about at this stage also (according to Google)…
The prefrontal cortex (PFC) is the cerebral cortex covering the front part of the frontal lobe. This brain region has been implicated in planning complex cognitive behaviour, personality expression, decision making, and moderating social behaviour.
The amygdala (Latin, corpus amygdaloideum) is an almond-shape set of neurons located deep in the brain’s medial temporal lobe. This part of the brain plays a key role in the processing of emotions. The amygdala forms part of the limbic system.
It’s important to understand how your psychological state affects your investment decisions. The rule we should have to ‘Never go shopping on an empty stomach’ applies when investing: ‘Never invest using your primal gut instincts alone’. Don’t discount feelings entirely though, especially what you perceive to be the aggregated feelings of other investors. Fear can often be more motivating as it’s drawing on our primal mind, and its origin is instinct rather than well thought out strategy using rational thought.
Other key points to finish up with:
–The herd is to be respected – being a contrarian and betting against the trend can pay off big time, but it can also lead to pretty big losses: The trend is your friend.
– Just because the parties getting out of control, doesn’t mean you can’t stay a little longer, just stay dancing as close to the exit as you can.
– You don’t have to subscribe to just one paradigm. For example, passive vs active, fundamental vs technical – there’s a time and place for everything with investing. For eg, if you looked at the fundamentals too much, you’d miss out on a lot of the action we’ve seen over the last two years.
– Confirmation bias – seeking out info that supports your underlying belief system. This can also play out in our paradigms of understanding financial markets. Interest rate direction used to be a predictor of asset markets – this has clearly changed with the extension of the longest bull run in history.
Other Links to check out:
Check out Mike Taylors ‘origin story’ here. you’d like to hear more of his ‘origin story’, check out episode 25 – it’s a good listen.
Book: Fear, Greed & Panic: The Psychology of the Stock Market. This is the book that Mike mentioned by David B. Cohen .
If you’d like to learn more about Pie Funds or check out Juno Kiwisaver, visit https://www.piefunds.co.nz/