Owl_R Owl_L RACHEL ABRAMSON & ASSOCIATES
smoking    -    weight    -    career guidance

Psychologists, Career Counsellors, Hypnotherapists and Relationship Counsellors

Psychology of Investing

This page has been set up as a blog with new material being added each Monday. You will see information about common psychological factors that influence the behavior of share investors. You will also see tips and suggestions on the psychology of investing. Much of what you will see in this blog comes directly from Dr. Abramson's doctoral research. If you like what you read, feel free to bookmark this page so that you can return to it on a regular basis. And for now, you can scroll down to learn about:

How to Know if You Have a Profitable Investment

Have you ever invested in shares in a particular company and watched the share price fall after you invested? Ouch! Have you held on for years afterwards in the hope that the share price will recover? And, you are still waiting?

Perhaps you are so disappointed with your early investment choices that you have yet to make any further share investments. Good money after bad? If so, you may regard investing as just another form of gambling, but is it?

You may have seen something that the rest of the share market has yet to see. If so, you have taken a big risk that may take many years to bear fruit. The risk that you have taken may be much greater than you realise. If so, you may have placed more capital in the share investment than you are actually prepared to lose. It is only natural to feel frustration and disappointment when you see the share price continually fall from your initial purchase price.

Perhaps you have recognised a great new investment opportunity that other share investors have also recognised, but acted once everyone else has already invested in the asset and are now seeking to capitalise their gains.

Perhaps you are the only one to recognise this investment opportunity but there are factors you had not considered (both internal to the company and external). If so, it may be a factor of where you source your information, and the range of information sources you utilise.

Yet, it is possible to make share investments that consistently grow over time, giving you ongoing dividend income and/or capital growth from your investments. The secret is all psychology: Yours and those of groups of investor who operate on masse with one another (such as mum-and-dad investors or institutional investors).

Trading and Investing - Are they Forms of Gambling?

I have often been asked whether trading and investing are forms of gambling. Trading and investing are different activities with different time horizons. Traders may buy shares that are rising in value with the intent on selling them for a capital gain over a short period of time (such as 24 or 48 hours). However, you have to time it so that you get out before the direction of trading changes. This can be a gamble.

Investing involves researching shares of a particular company to identify whether or not they are worthwhile to buy with a view to holding 3-5 years, perhaps indefinitely. As an investor, you may consider what the company behind the shares does and how they do what they do. If you like the what/how, you may then consider the pricing of its shares. The underlying value of a company's shares may differ from how much you can buy/sell them for. When you know how much a company's shares are genuinely worth, you have taken much of the 'gamble' out of the investing equation. The better you are at valuing shares, the better you will be at buying shares at a fair, or discounted, price. And, when you buy well, you can ultimately sell well.

Bubbles and Crashes

Psychology of Investing, Part I There have been times in the history of the share market where share prices have risen higher or fallen lower than was called for (eg., tulip bubble, internet bubble and the great depression). In each case, investors recognised a great new investment opportunity. They all wanted to ride the wave up (and enjoy nice, healthy capital gains). But it gets to a point where there are no new buyers to buy from you and existing investors are ready to capitalise their gains. When that happens, the price of that great new investment opportunity starts to reverse and then fall to pre-bubble prices. In the case of the great depression, the whole market collapsed. Even shares in valuable companies became highly discounted to what they were really worth. Shares in speculative companies became worthless.

Why does this continue to happen over time? Perhaps because investors and traders 'there' for one bubble (and its subsequent collapse), were financially burnt, so much so that they have no interest in the next one. In some cases, they were no longer alive to warn their children or grandchildren about their experiences. Each generation of investors are left to learn this lesson for themselves - unless they read or listen to some sound financial training provided by independent professionals, as is the case with my three talks. At the end of the day, we can focus on investing in shares that have a strong/solid financial base and for which we would be comfortable to hold indefinitely.

Psychology of Share Investors Benjamin Graham was one of the first to recognise the volatility we see in share markets. He coined the term Mr. Market to personify share market behavior. [Graham's book was initially published in 1949 - a time when most investors were men. The salutation of Mr. was thus very apt for the times]. Graham recognised that Mr. Market may act rationally for most of the time, but that there would be periods where Mr. Market would become euphoric and seek to invest in shares, no matter what the price. Graham also recognised that there would be other times when Mr. Market would become despondent or fearful and would try to sell out of his holdings, no matter how little he might get for his holdings. Graham advised investors to ignore the gyrations of the share market and only approach Mr. Market when we want to buy or sell shares. He also advised investors to buy when Mr. Market is keen to sell and sell when Mr. Market is keen to buy. In so doing, we can buy well to sell well. Warren Buffett has used a variant on Graham's approach, with consistently remarkable results.

Investor Overconfidence

The personification of Mr. Market begs the question of what might be going on behind the extremes of euphoria and fear within Mr. Market's behavior. This section introduces overconfidence as one of those qualities behind the behavior of Mr. Market. I will speak more about overconfidence over the next few weeks as well as introduce two more qualities that may help explain Mr. Market's behaviour.

Share investors can sit somewhere on a continuum of confidence; with one end of the continuum representing a lack confidence (i.e., underconfidence) while the other end of the continuum representing overconfidence. The middle of the same continuum represents a healthy level of confidence. Underconfident investors may invest in blue chip investments with the intention of holding them for the long-term. Overconfident investors may make more risky investment decisions and turn over their share investments more quickly. Past research has shown that overconfident investors do trade more and that those trades have a deleterious effect on portfolio wealth. That same past research has also found that men trade more than women and that the difference in overconfidence is even more pronounced for single men than it is for married men.

Investor Overreaction

Psychological Aspects of Wealh Creation When you look at the share market as a whole, you can see that there are times when shares in certain companies are avoided i.e., losers while shares in other companies are highly sought-after, i.e., winners. What is interesting is that academic research has consistently shown losers outperform winners for up to five years. Investors acting in tandem appear to overreact. It seems the Grahamian concept of buying when Mr. Market is fearful and selling when Mr. Market is euphoric has its wisdom.

What is also interesting is that individual and institutional investors can seem to be acting in tandem with one another to the point that there is an upward pull on share prices at times of euphoria and a downward push on share prices at times of fear. To outside observers (and indeed, the academic world), it can seem as if investors are acting irrationally. I prefer the term human. More about in the next section.

Appetite for Financial Risk

Just as our position along a continuum of confidence can vary, so too, can our position along a continuum of risk appetite. The greater the appetite for financial risk, the riskier the share investments we are prepared to invest in. The lower our appetite for financial risk, the more we are inclined to make conservative share investments.

Irrespective of where we sit along the continuum of risk appetite, it would appear that we are more inclined to acept the risk while share prices are increasing (and congratulate ourselves for excellent share selection). However, we are not prepared to accept the same degree of risk when share prices are falling. We often find ourselves dramatically changing our share selection at such times or pulling out of the share market all together.

This is why it becomes very important to understand the true degree of risk we are taking on in our share investments. It may mean making more conservative decisions than we might think we want in good economic times so that we are comfortable riding out the poor economic times. Confidently.

Information and Social Herding

How does it happen that investors overreact? How do they get to overreact in tandem with other investors? The academic literature refer to social herding, where investors have a tendency to follow the crowd. There may be a sense of safety in being where everyone else is, when they are. There is research to suggest that social herding even occurs with stock brokers, where they all follow one another in the recommendations that they make.

But, there is more. Decisions are made on information. And, investors get their information from the same sources: The media (e.g., print, radio, T.V.). If you are accessing the same media at the same time as fellow investors, you will be reaching similar decisions, and taking similar steps, at the same time as your fellow investors. When that happens, the market as a whole will appear to be operating as one big social herd.

So, what does this mean for us as investors? Perhaps use other means of keeping yourself informed about your investments. If you are accessing the same media as fellow investors, consider how other investors might respond to this information before deciding what steps to take on your own investments.

The January and July Effects

The January Effect is a phenomenon where share prices dip over the last few days in December of a calendar year and bounce back in the early days of January. The January Effect was first observed in the U.S. where the financial year aligns with the calendar year but it has been observed in other countries, not just those where the tax year aligns with the calendar year. In Australia, there is both a January and July effect. The January Effect has been attributed to tax-loss selling and portfolio rebalancing. It has also been attributed to a pooling of funds from share sales with those from other sources (including holiday bonuses) before making any fresh purchases in the new year.

Fight - Flight - Freeze

Our brains have been wired to respond to life-threatening events. If we see a hungry lion hungrily licking its lips while looking at us, we are not going to stop cuddle it or stroke its fur. The moment we sense the presence of that hungry lion we are running. We may even be running for our lives before we consciously realise that it was a lion we saw. If it is a different kind of animal we think we saw, we may choose to prepare ourselves to stay and fight.

This response is typical of fight/flight behaviour. It is triggered by a small area in our mid-brains known as the amygdala. The amygdala is often called our danger detector. The amygdala cannot distinguish between that which might literally kill us (such as a hungry lion) or something that might cause us distress (such as an angry boss or dramatic share market decline). The amygdala is able to evoke action before we are consciously aware of what is happening by flooding us with fear and anxiety. The amygdala will simultaneously slow down any digestive processes happening within the body and prepare our major muscle groups for fighting or fleeing. It may be only after we have begun running for our lives (literally or figuratively speaking), that our conscious minds may catch up with us and wonder what we are doing. By that time, we may have already taken action based on the levels of fear or anxiety coursing through our bodies.

It is interesting to note that the amygdala may also cause us to freeze in what it considers to be a life-threatening situation. You may have seen animals roll over and play dead when they are overwhelmed by a situation that could prove deadly for them. Many people seem to freeze when called upon to speak in public. While public speaking is not life-threatening, we may feel as if our whole life depends on how well we perform on the stage. If we find ourselves freezing, we could find ourselves unable to express our thoughts or ideas. Indeed, we may even find ourselves feeling so overwhelmed that words are just not available to us. What we may not be aware of is that our breathing becomes quite shallow when we freeze, so much so that we are not fully oxygenating our bodies.

So, what should we do if we find ourselves flooded with emotions of fear or anxiety? If we find ourselves metaphorically running for our lives, we need to stop and remind ourselves that, chances are, we are not being faced with a hungry lion. We need to give our conscious minds a chance to catch up. And, we can do that by slowing ourselves down. Breathe. Breathe deeply. Ask ourselves (a) what is actually going on; (b) what would we like to have happen; and (c) how might we best have that happen.

If we metaphorically find ourselves freezing, so much so that we are too nervous to articulate our thoughts or ideas, we need to remind ourselves that our audience is not made up of hungry lions. Once again, we need to slow ourselves down and ensure our whole body is properly oxygenated. We can best do that by breathing deeply (before, during and after the talk). We may also find it helpful to rehearse the talk (imaginally or in vivo) until the talk unfolds the way we want it to. You will also find it helpful to visualise a positive progression and outcome of your talk. Finally, it is often helpful to do a full body stretch, standing as tall as you can before you walk up to the podium. Doing so will give you an added boost of much-needed confidence.

For many of us, these strategies may be all you need to manage the levels of fear and anxiety evoked by our amygdalae. However, if you find these strategies insufficient to help you manage the level of fear and anxiety, perhaps it is time to book an appointment for hypnotherapy with Dr. Abramson.

Money Quarters

Our newsletter, Money Quarters, provides articles, quick tips, food for thought to help you reach your full potential: Money-wise. If you would like your own complimentary subscription to this newsletter, feel free to email your request to Dr. Rachel Abramson . You can also follow Dr. Abramson on Facebook or Twitter.

Disclaimer

The ideas expressed in this blog take a psychological perspective on share investing. Similarly, the ideas expressed in the Psychology of Money blog take a psychological perspective on money and finance. The ideas expressed in both blogs should not be construed as financial advice, but instead, provide food for thought on how your own psychology may have an impact on your wealth (short-term, medium-term and long-term). You would be well-served to see a shrewd accountant if you would like financial advice pertaining to your own circumstances. You can book an appointment with us, if you would like advice managing your own psychology with money or investing.

Buy well to sell well.
Dr. Rachel Abramson.

The Jewel, 3rd floor, Suite 307, 566 St Kilda Road, Melbourne, Australia
OUR MISSION: To provide a professional service, using best practices.
OUR MOTTO:   Be proactive. Take charge of your career. Look after your health.
OUR HIGHER ORDER CALLING: To help people reach their full potential: Personally, professionally, entrepreneurially and money-wise.

Owl_L

Suite 307, 566 St Kilda Road, Melbourne
P O Box 300, Caulfield South Vic 3162
0418 149 506
rachela@ozemail.com.au
Twitter: @Rachel_Abramson
Skype: rachel.abramson.and.associates
www.rachel-abramson-and-associates.com.au
ABN: 74 923 166 311