This concept was originally published as part of our Tiny CAPS report on 18 Nov’18. To suit AI post, certain portions have been modified for easy understanding.
Today’s AI post focuses on the behavioral aspect of investment. Emotions play a far larger role in wealth creation than any high end analytical or robotic capabilities. In equity, your EQ (Emotional Quotient) matter more than your IQ (Intelligence quotient). There is a famous saying from Warren Buffet that “Buy when there is blood on wall street and sell when there is euphoria”. I know you have read it several times all over the internet but are we able to implement it when time is right? Currently, there is blood on at least dalal street which means we should be buying Indian stocks right now but how many of us have that courage to do it?
If this question was asked last year, I am sure many would have said, “Surely, I can implement what Mr Buffet is saying during next stock correction”. Knowing the path is one thing, walking down that path is another. Do you know why this happens? Fear, of course is one short answer but we are looking in-depth here. What induces this fear? How come last year’s confident & aggressive investor has transformed into unsure & risk-averse investor. This is what we are trying to answer in today’s AI Post. We have coined this phenomenon into a term “Bear Market Brainwash”. Let’s read about it.
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Bull Market Brainwash
Our brain controls our emotion. It is a very powerful tool if harnessed carefully. During bull market there is positivity and success all around us. Stock prices are going up. Good or bad all stocks have something to gain. After sometime, all good stocks already become very costly and stop going up. At this time all late comers, try their hands in riskier stocks in order to bargain more returns. Being bull market, they may succeed in short term. This cycle is repeated. Suddenly, every investor becomes expert and more and more unknown names crop up. At this point in time, our brains have gotten used to success and we start to think that we should take more risk in search of more returns. We think it can be called as “Bull Market Brainwash”.
Bear Market Brainwash
Almost opposite happens in a bear market. At the start of bear market, many investors remain very confident and want to take advantage of falling stock prices. Unfortunately, the stars of bull market fall first due to profit booking. Some investor try to latch on these falling knifes, thinking they will again go up shortly since bear market is not yet officially announced. They seldom reverse falling trend and gets investors trapped. Often, these are individual investors who are playing in stock market with less or no guidance or knowledge. They are good in doing internet research and look for clues from different forums, whatsapp groups, etc but never want to spend money to hire some professional advisory services.
Going deep into the bear market. Now, even good and big names also start to tumble. Good or bad all stocks are in red. Television experts declare that we are in a bear market. Some will term it as mini correction in a bull market. All kind of theories are circulated and it further confuses investor. Some time more into bear market, rumors start to spread and good stocks fall like pack of cards. By this time our once confident and aggressive investor begins to doubt himself. He wonders if he is on the right track. To search answers, he does more internet research and shuffles through popular forums only to reinforce a notion that stock market is all rigged and I should stay away from it. Some may have a different notion but on similar lines.
This process of doing daily internet search and shouting in forums & whatsapp takes a toll on our mind. You see, our mind is a very powerful tool but it is also a constant learner. If you surround it with negative thoughts on a daily basis then it will change your belief about stock market sooner or later. It will not be of much use if you were very confident a year back. This negativity nibbles out your investment confidence slowly & steadily. Often, we do not realize this damage. Remember the story of a frog who dies inside boiling water but never jumps out of it because water temperature is raised slowly. The frog could not notice the change in water temperature and think this is the new normal. This is exactly how bear market brainwashing works. With increasing penetration of smart phones & television, keeping our mind and hence emotions under control is becoming difficult day by day. This may result in shorter bull and bear market cycles in the future as people will get easily influenced by these factors.
What does History tells us?
It has been 11 months since correction started in small cap in the beginning of 2018. BSE Small cap index went down to -33% at one point of time and currently staring at -25% as compared to January’18 levels. Such a deep correction is not a regular occurrence as historically we have only seen such correction once in 5-6 years on an average. So there are good reasons to believe that we will not see such corrections again till 2022-23 kind of time-frame. If we dig deep into the historic data, we find that since 2003 there has been only two instances when small cap index went down -20%. We have data starting 2003 as BSE started recording small index since Apr’2003 only. Let’s see what historic data tells us. Hopefully, it can ignite some positive sparks in you.
- Worst ever correction was of -72% during 2008 financial meltdown. It was immediately followed by +127% gains in 2009.
- Second worst correction was of -43% in 2011. This was again followed by +246 gains until 2017.
- Third worst correction is now of -25%. You can guess what will follow from here.
- Mother of all bull runs from 2003 until 2007 in which index gained a mammoth +449%. This is at index level, imagine how much money individual stocks would have made during this 4 years period.
- Most silent period was observed between 2009 till 2013 during which index gained only a meager 21% in 4 years period. Poor than bank fixed deposit.
How to avoid a brainwash?
- Have a solid investment theory in place. One needs to have a good investment theory about each investment. Now, there are lot of misconceptions about investment theory. It does not need to be very technical or complicated. It can be anything which you can believe, understand & stick to it. This theory can differ from person to person. Someone who is an investment expert, it can be based on business model, financial performance, etc. For someone who is a beginner, it can be restricting himself to well diversified mutual funds. Some people may want to get more returns than mutual funds by investing into direct stocks but they don’t have enough time & expertise. For them investment theory can be to follow recommendations from any good stock advisor. As we always say, go for an independent stock advisor. Never ever trust a broker cum advisor model. So choose your investment theory or principles and stick with it. Remember stock market moves in cycles, you need to stick with one strategy to benefit from cyclic nature else following latest trend will always keep you behind the curve.
- Understand your risk appetite: There is no harm in being a conservative investor if stock market correction don’t let you sleep well at night. Similarly, there is no harm in being an aggressive investor if you can carry it off during bear market. Ones need to invest only surplus money into equities which is not needed for next 4 or 5 years. Keep your emergency funds ready before starting investment. This will enable you to wait for correction to be over. Otherwise you will get panic irrespective of your risk appetite.
- Daily undo the damage caused by news: As explained above, one of the biggest culprit of our brainwash is either smartphone in our hand or television in our house. As a habit, we keep on checking stock prices on a daily basis. Honestly, this is unavoidable during modern times. During bear market, often there is lot of negativity on these channels leading to damage to our “investment belief system”. You can undo it by asking yourself these simple questions:
- What does my investment theory say?
- Did I invest for short term or long term?
- Can I afford to wait until next bull run?
- “Buy when there is blood on the street and sell during euphoria”- Am I following it?
- I don’t have to take a decision right now, let me go back, take a little time out and think over it once my emotions have cooled down.
If you follow these steps, there are high chances that bull or bear market both will not be able to sway you away from rational behavior. We at AI, are also humans and can be susceptible to emotional stress of equities. To mitigate it, we have pasted a chart on the wall which can be seen on a daily basis. Apart from these general aspects, condition in your personal life & physical fitness can also play a big role in your investment behavior.
Dear Ace readers, year-end holidays are near, you will get some time off to think about how to approach investments in the future. With every bull & bear market, we must get smarter by learning the valuable lessons from our experience. All the best.
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