THE 14 STAGES OF INVESTOR EMOTIONS
Efficient Markets are based on the assumption that rational people enter transactions with the intent to maximize gains and minimize losses. While this theory is sound, most investors are not the purely rational robots that efficient markets rely upon. Instead, emotions often cloud our decision-making and prevent us from acting in a rational manner.
Knowing we can never conquer our inherent emotional biases, we should seek to understand the range of emotions we may experience as investors and how it affects our interactions with the market. A common market psychology cycle exists that shines light on how emotions evolve and the effect they have on our decisions. By understanding the stages of this cycle, we can tame the emotional roller coaster.
The chart below is a visual representation of the 14 stages that I’ll cover below. This would be a great visual to print out and put in your office or desk to remind you to ask yourself: “Where am I right now?”
1. OPTIMISM – It all starts with a hunch or a positive outlook leading us to buy a stock.
2. EXCITEMENT – Things start moving our way and we get giddy inside. We start to anticipate and hope that a possible success story is in the making.
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3. THRILL – The market continues to be favorable and we just can’t help but start
to feel a little “Smart.” At this point we have complete confidence in trading system.
4. EUPHORIA – This marks the point of maximum financial risk but also maximum financial gain. Our investments turn into quick and easy profits, so we begin to ignore the basic concept of risk We now start trading anything that we can get our hands on to make a buck.
5. ANXIETY – Oh no – it’s turning around! The markets start to show their first signs of taking your “hard earned” gains back. But having never seen this happen, we still remain ultra greedy and think the long-term trend is higher.
6. DENIAL – The markets don’t turn as quickly as we had hoped. There must be something wrong we think to ourselves. Our “long-term” view now shortens to a near-term hope of an improvement.
7. FEAR – Reality sets in that we are not as smart as we once thought. Instead of being confident in our trading we become confused. At this point we should get out with a small profit and move on but we don’t for some stupid reason.
8. DESPERATION – All gains have been lost at this point. We had our chance to profit and missed it. Not knowing how to act, we attempt to do anything that will bring our positions back into the black.
9. PANIC – The most emotional period by far. We are clueless and helpless. At this stage we feel like we are at the mercy of the market and have absolutely no control.
10. CAPITULATION – We have reached our breaking point and sell our positions at any price. So long as we can get out of the market to avoid bigger losses we are content.
11. DESPONDENCY – After exiting the markets we do not want to buy stocks ever again. The markets are not for us and should be avoided like the plague. However, this rare point marks the point of maximum financial opportunity.
12. DEPRESSION – We drink, cry and/or pray. How could we have been so dumb we think to ourselves. Some start to correctly look back and analyze what went wrong. Real traders are born here, learning from past mistakes.
13. HOPE – We can still do this! Eventually we return come to the realization the market actually does have cycles (shocking). We begin to start analyzing new opportunities.
14. RELIEF – The markets are turning positive again and we see our prior investment come back around. We regain our faith (although small) in our ability to invest our money. The cycle start all over again!
Individuals clearly follow this cycle in their decision making process.
Since broad indices like Nifty 50 are comprised of the decision
of millions of individuals, we should expect index prices to track
this pattern as well. If we are aware of the stage of the cycle we are
experiencing at a given point in time we will have a greater grasp of
how our emotions are affecting our investment decisions. This knowledge
will help us manage our own investment portfolios as well as predict
the next step for the broad market.
Harsh Dixit.
MBA | CFA
Trader | Investor | Trainer | Mentor
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Kindly Give Your Opinion in Comment Box which stage are we in according to you?
Nice analogy!
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