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Business News/ Markets / The psychology of an investor: The age-old story of fear and seduction

The psychology of an investor: The age-old story of fear and seduction

Some investors get impacted by volatility as it brings out their greed and fear.

An investor has to live with and adapt to market extremities. (Pixabay)Premium
An investor has to live with and adapt to market extremities. (Pixabay)

Since 1981, Sensex has given a CAGR of about 15%. This is what an average investor can aim for over the long run, which is pretty decent when compared to other asset classes.

But yet, how do some people still make lower returns or even losses in markets only to bow out and say never again?

The answer to this lies in the investor’s psychology. Volatility combined with fear and market seduction is partly to blame.

Starting with volatility, if you look at the same timeframe, on a year-on-year (YoY) basis, only 5 out of those 41 years have given an annual return between 12-18% (+/-300bps over the average) whereas, for the remaining 36 years, markets have moved wildly between -50% to 78%.

This illustrates that while markets generally go up – it is not in a linear progression but also through wild swings.

Some investors get impacted by this volatility as it brings out their greed and fear. They can become too excited by the call of the siren as they refuse to sit on the sidelines and watch others become rich.

They then buy when valuations are already expensive. On the flip side, they become the victim of fear and sell when things are too cheap because they have invested through vicarious research without understanding the true intrinsic value of the company that they own.

In two years, we have already experienced these extremities when even screenshots of cartoon monkeys (NFTs) were being sold at millions of dollars as people created stories to justify these valuations.

While today, under the cloud of inflation, quantitative tightening and geopolitical conflict, people choose to sell at any cost to avoid feeling any more pain.

An investor has to live with and adapt to these market extremities. The pendulum moves from extreme fear to extreme greed and hardly it remains at the centre (just five years out of 41 years).

Ideally, ₹10,000 invested in 1981 would have become ₹28.7 lakhs today and that too without doing anything. That's a stellar return!

Yet how many Investors actually make that? Buy and hold is not an easy game to play.

So, what can one do?

First, one needs to accept the fact that fundamental analysis is not necessarily stock price analysis. Stock prices and fundamentals don’t necessarily move in line with each other.

If one were to jot down a company's financials of the last 20-30 years and see the volatility in the profits versus the volatility in stock price, one would see that profit volatility is much lower than stock price volatility.

Stock prices are impacted by fundamentals as well as people's perceptions. If a group is expecting a recession and this fear spreads like wildfire, this can snowball into moving the markets into a negative zone.

People's behaviour cannot be predicted and should not be predicted. It is something that is not in our hands, but it is something that definitely impacts stock prices.

While I reserve the right to be wrong, a simple indicator one might consider is the “WhatsApp indicator".

Sometimes I note when my WhatsApp chats are lighting up with noise and comments like “the stock market is a casino", “I’ve lost so much that I am leaving these stocks for the grandkids" and similar, I may consider holdfast or even increase my position.

On the other side, when people give wild predictions or say “Crypto Punk NFTs – they are the future of art".

This might be an indication of wild froth. Of course, this is by no means a perfect indicator, but it may help understand where the general herd are heading.

For an investor seeking to gain from the market, it is important to study a company's intrinsic value.

Emotional investments usually aren’t a great basis for an investment philosophy.

The markets are unpredictable, but if one can be resilient, patient and observant, there are gains to be made in the market and that’s how fear and seduction can be beaten to make a profit in the current markets.

(The author of this article is the co-founder of First Water Capital Fund)

Disclaimer: The views and recommendations given in this article are those of the author. These do not represent the views of MintGenie.

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Published: 13 Nov 2022, 10:04 AM IST
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