When it comes to equity market, we always look at it as risky, volatile and hard to predict. However, as humans and investors, if we look into ourselves then we noticed that we have certain stubborn features.
Let us discuss those 5 constant features of the equity market in detail. These features will remain the same in the past, current, and future too.
5 immortal features of Equity Market Investors
In this 2014 article of Wall Street Journal, they mentioned an interesting point of what Jason Zweig found “Over the last 30 years the S&P 500 was up 11.1% and yet the average investor in all U.S. stock mutual funds experienced the performance of a mere 3.7%. What gives?”.
Let me share the quote from Benjamin Graham.
“The chief hazard of a careful common stock program is not that it may bring unexpected losses, but that its profits will turn the investor into a speculator greedy for quicker and bigger gains — and therefore headed for ultimate disaster.”
The answer is simple. We never view the stock market as a long-term friend. Rather we always have greed inside to create wealth instantly.
Looking at the past and current market conditions, you can easily notice that people are greedy and think the equity market is a kind of place where you can turn wealthy in few years.
No matter whatever the gyaan you preach, this conception will never change. It is mainly because of few so-called experts, media, or social media noise. They will showcase fantastic past returns and force us to believe that the same may happen in the future.
Hence, with this intention people invest in the equity market by taking high-risk investment strategies. Because the idea is to generate as high as possible returns.
Hence, greed is the nature of humans which never changed nor will change in the equity market.
If you notice the whole equity market, it revolves around greed and fear. Because we humans flactuare between fear and greed. Fear of losing money or less returns. This fear actually a good thing. However, not understanding how the market works and not preparing for equity market volatility will create more fear inside us.
Howard Marks in his 2004 memo explained this fear concept beautifully as below.
“It didn’t take long in my early days, however, for me to realize that often the market is driven by
greed or fear. At the times that really count, large numbers of people leave one end of the rope for
the other. Either the greedy or the fearful predominate, and they move the market dramatically.
When there’s only greed and no fear, for example, everyone wants to buy, no one wants to sell,
and few people can think of reasons why prices shouldn’t rise. And so they do – often in leaps
and bounds and with no apparent governor.”
“But eventually, something changes. Either a stumbling block materializes, or a prominent company reports a problem, or an exogenous factor intrudes. Prices can even fall under their own weight or are based on a downturn in psychology with no obvious cause. Certainly, no one I know can say exactly what it was that burst the tech stock bubble in 2000. But somehow the greed evaporated and fear took over. “Buy before you miss out” was replaced by “Sell before it goes to zero.”
And thus fear comes into the ascendancy. People don’t worry about missing opportunities; they worry about losing money. Irrational exuberance is replaced by excessive caution. Whereas in 1999 pie-in-the-sky forecasts for a decade out were embraced warmly, in 2002 investors chastened by the corporate scandals said, “I’ll never trust management again” and “How can I be sure any financial statements are accurate?” Thus almost no one wanted to buy the bonds of the scandal-plagued companies, for example, and they sunk to giveaway prices. It’s from the extremes of the cycle of fear and greed that arise the greatest investment profits, as distressed debt demonstrated last year.”
Fear was and is the constant mindset of investors. However, the best way to come out from such fear is to make sure that you have a proper asset allocation of equity and debt. Along with that, accept the reality that the equity market is volatile in nature (especially in short term).
# Herd Mentality
In 1951, Asch conducted his first conformity laboratory experiments at Swarthmore College, laying the foundation for his remaining conformity studies. The experiment was published on two occasions.
Groups of eight male college students participated in a simple “perceptual” task. In reality, all but one of the participants were actors, and the true focus of the study was on how the remaining participant would react to the actors’ behavior.
The actors knew the true aim of the experiment but were introduced to the subject as other participants. Each student viewed a card with a line on it, followed by another with three lines labeled A, B, and C. One of these lines was the same as that on the first card, and the other two lines were clearly longer or shorter (i.e., a near-100% rate of correct responding was expected). Each participant was then asked to say aloud which line matched the length of that on the first card. Before the experiment, all actors were given detailed instructions on how they should respond to each trial (card presentation). They would always unanimously nominate one comparator, but on certain trials they would give the correct response and on others, an incorrect response. The group was seated such that the real participant always responded last.
In the control group, with no pressure to conform to actors, the error rate on the critical stimuli was less than 1%.
In the actor condition also, the majority of participants’ responses remained correct (63.2%), but a sizable minority of responses conformed to the actors’ (incorrect) answer (36.8 percent). The responses revealed strong individual differences: Only 5 percent of participants were always swayed by the crowd. 25 percent of the sample consistently defied majority opinion, with the rest conforming on some trials. An examination of all critical trials in the experimental group revealed that one-third of all responses were incorrect. These incorrect responses often matched the incorrect response of the majority group (i.e., actors). Overall, 75% of participants gave at least one incorrect answer out of the 12 critical trials. In his opinion regarding the study results, Asch put it this way: “That intelligent, well-meaning, young people are willing to call white black is a matter of concern.“
We love to follow the group or trend. Mainly because of various reasons like we feel inferior of our knowledge, we feel the group is more knowledgeable and control over the outcome or sometimes we fail to think independently.
This applies to the equity market also. We love to follow social media groups or few individuals who as per us are experts. But we fail to understand one aspect when it comes to investment, each of our financial life and risk-taking ability is different.
# FOMO (Fear of Missing Out)
Fear which I mentioned is a different one than the fear of missing out (FOMO). In the case of normal fear which I pointed out above is something like losing money or loss-making. However, FOMO stands for fear of missing the bus of high returns. This happens especially during the bull market.
When your friend is investing in a stock or particular sector and daily he is gaining something, then obviously you too feel that if you do not invest then you may lose the opportunity of earning.
Hence, BLINDLY you take the route of your friend without understanding his capability, risk, and his financial life by comparing with yours.
Vishal Khandelwal of Safal Niveshak explained this nicely with the image.
If you look at all past bubbles of stock market, you notice this FOMO. Blind following just because someone is investing and turning success means we too hope that same may happen to us also. We never realize our own risk and we never analyze what we want from our own investment.
# Change in risk tolerance
Yesterday I tweeted as below.
As I mentioned in the above twet, the feature of Bank FDs and equity market never changed. However, it is our perception of how we look during bull and bear market changed our risk tolerance and the way to look at risk.
We as investors many times fail to analyze the risk from nuetral form (without looking at current market condition). This leads to take huge risk during bull market and turn completely a risk averse during bear market.
Try to look at your risk tolerance and you noticed this change. In fact in few cases such change happen due to age, financial freedom or many other aspects. However, change in risk tolerance due to market condition is disaster.
Let me know if you have found any addition to above list!!