Have you seen the depiction of the Cycle of Market Emotions? You're probably familiar with the wave that starts out with optimism, excitement and thrill; peaking at the point of maximum financial risk with euphoria; the downward spiral of of anxiety, denial, fear, desperation, panic and finally capitulation; followed by a slide along the bottom into despondency and depression. Finally, this all gives way to hope and relief, to bring us full circle back to a state of optimism. Take a guess at which stage most people buy stocks and when most investors sell-out.
Almost all of us react emotionally, with alarming consistency, especially when it comes to money. Recently, developments in the study of behavioural finance put us on the leading edge of really understanding how we behave and more importantly, 'how to' behave in our financial world. Imagine how much more successful you would be if you only knew how long the climb of excitement to euphoria would last. You don't want to miss the profitable rise in values and the cocktail-party banter that goes with it, but you don't want to be the last fool left holding the bag either.
Even better still, if you could predict when others were capitulating, you could pick up some bargains, if you weren't suffering from the same panic as everyone else. Unfortunately, the Cycle of Market Emotions isn't always as clearly dramatic as the 2008 financial crisis. More often than not, the long-term trend is mixed with many mini-cycles, just to throw you off course.
Coupled with the outside noise of market emotions, our individual ability to justify decisions based on sometimes irrelevant and biased information, makes the seemingly simple axiom, 'buy low, sell high' difficult to execute efficiently. Luckily, there are 3 easy ways that you can create and manage an emotional firewall between you and your investments:
1) Tactical Asset Allocation is a strategy of religiously re-balancing your portfolio of investments. Regularly resetting the values of each asset class, sector or individual stocks or bonds, forces you to sell positions that have appreciated in value and buy those that have declined (a.k.a. sell high, buy low).
2) Hire a professional with a proven investment discipline. Don't just look at past returns but select someone who can articulate a strategy and has checks in place to ensure that she sticks to it.
3) Write down your investment objectives, permissible types of securities, your buy and sell process, as well as the variability of returns that you are prepared to withstand. An Investment Policy Statement will save your bacon every single time, if you follow the convictions that you wrote down during more rational times.
On a road with no signposts, wandering around and changing directions won't get you to your destination. Before you leave home, make sure you have a compass.
This information should not be construed as investment advice, nor can it take into account your own specific circumstances. The opinions formulated within this article are based on sources believed to be reliable and may not reflect the opinions of any organizations that I am affiliated with.