Navigating the complex stock market terrains

“This time it’s different” is a four-word expression I dread the most. Of course, it’s true that the factors contributing to the rise of the current markets are different from that of the last. Though investors have learnt from the past market corrections of ‘00 and ‘08, it’s wrong to assume that other investors don’t suddenly sell their holdings and get out of the stock market.

Despite the overwhelming evidence that the market is usually correct, there’ve been a handful of instances where the market consensus was grossly inaccurate. These errors typically occur during moments of high emotions and they defy logic. The famous expression by Allan Greenspan during the dot-com boom “irrational exuberance” lead to panic correction in the world markets. In ‘The theory of Cognitive Dissonance’, Edward Chancellor wrote that people will tolerate increasing degree of dissonance if they are motivated by a sufficiently enticing reward.

Markets operate between two forces i.e. greed and fear while worry is the common characteristic of an investor. They worry if the market peaks up or bottoms down. John Maynard Keynes once suggested that investors don’t actually make money by picking the best companies but by picking stocks that waves of other traders will want to buy. Investing in other words is an exercise of mass psychology.

Are the current investors primed psychologically for a major decline in the stock market or are they likely to keep bidding up stocks for some more time to come? Those are the critical questions. So how do you resist the madness of the crowd? I would outline some suggestions at the end of this article.

Robert Cialdini explains why this happens in his book, Influence: The Power of Persuasion."So massive was the commitment to their beliefs that no other truth was tolerable. Yet that set of beliefs had just taken a merciless pounding from physical reality. Since the only acceptable form of truth had been undercut by physical proof, there was but one way out of the corner for the group. They had to establish another type of proof for the validity of their beliefs: social proof," he says.

Social proof is the idea that we look to others to figure out what the correct behavior should be. Once we begin to follow narratives instead of evidence, it brings comfort to go along with the crowd especially when making tough decisions because we look at what others are doing in times of uncertainty. This is when we deviate from our own set goals, inhibitions and priorities - a dangerous sign.

Being right is easy. The true test however comes when one goes wrong. How one handles being wrong defines a successful investor. This is another important behavioral pattern to be noted. One of best parts about the markets is that they provide a running scorecard of your decisions. Though the market movements are mostly due to emotions, the results are always rational.

You can see your win-loss record by simply looking at your performance. Unfortunately, when people are wrong about the markets, many don’t balance their audacity with humility. They move the goalposts or change the narrative to fit their current worldview. Many investors are adamant being right irrespective of what the market does.

So, how to meander in this complex maze without getting lost? Define objectives and stick to it. Assess your risk and draw a tolerance level.
Don’t deviate from your investment philosophy. Do remember markets always provide opportunity. Be aware of the environment to re-examine your position. Don’t be harsh on mistakes but learn from them. Luck plays a part. Have a guide, take help. (The author is Head-Research & Planning with Wealocity, a wealth management firm and could be reached at knk@wealocity.com).

By K Naresh Kumar