Is the market Logical or Psychological?
The ever confusing question for the traders is, “should we analyze the market logically or psychologically? Few traders would understand that our trading result is greatly affected by our emotions. The emotional roller coasters generated due to market volatility is often responsible for behavioral mistakes of the traders. In this regard, there is an interesting article by Joachim Klement. Joachim Klement, CFA is a trustee of the CFA Institute Research Foundation. The excerpts:
Investing isn’t hectic, it is calm and measured.
Today you can check the value of your investments on a minute-by-minute basis if you want. But just because you can doesn’t mean you should.
It is hard for investment professionals to just sit there and do nothing. Resisting that urge to adjust your portfolio becomes particularly difficult when you’re faced with losses. Loss aversion means you suffer losses more than you enjoy gains. And what’s still the best way to avoid losses? Don’t look at your portfolio.
Assume an equity portfolio with a 10% annual return and volatility of 15%. The probability of a positive return over any given year is 93%. As a result, an investor who evaluates the portfolio once a year will experience a loss once every 10 years or so. If the same portfolio is evaluated quarterly, a loss will occur about once every four quarters, or once a year. And if that portfolio is evaluated daily, roughly 120 days a year will register losses.
It takes superhuman discipline not to change a portfolio when you are confronted with losses 120 times a year. But the best returns in the long run are achieved by adhering to a well-diversified investment strategy that lets you reap the benefits of the different risk premia available to long-term investors.
To stay calm and measured, you need to turn off your Bloomberg screen, close your Excel spreadsheets, look at your performance only sporadically, and avoid the temptation to tinker too often with your portfolio.
Investing isn’t rational, it is emotional.
The financial industry is incredibly innovative — mostly when it comes to reinventing the wheel. Thanks to all of these inventions like limited liability company, the stock exchange, diversification, the mutual fund, the index fund, options, or futures, investing has become cheaper, risk management more effective, markets more liquid, and access to investments more open. Ultimately, financial markets are among the most democratic institutions in the world today.
But very often financial innovation is a recipe for disaster. Investing may be rational, but money is emotional, and when risks — or opportunities — materialize, emotions take over and investors make crucial mistakes.
I have made it a rule to recommend only those investments that I have experienced myself. If a new innovation comes along, I tend to add it to my own portfolio with a little bit of money just to know what it’s like to live with it. Experiencing a new innovation firsthand will elicit the same emotions in me as it will in my clients. And only then can I judge if the investment is appropriate for a specific investor. Emotions cannot be imagined. As a portfolio manager or adviser, you have to experience them to improve your recommendations and decisions. Research shows that fund managers who invest much of their personal wealth in their mutual funds generally outperform.
Market- Hub Stock Broking Pvt. Ltd., based on our personal experience, we firmly believe that most of the clients are either unaware or are unwilling to accept the importance of emotions in trading. As a leading broker in Surat we have always made it a point to understand the errors incurred by the traders and investors and offer them a solution that can handle such errors. It is because of such initiatives by us that today, we are among the most reliable stock brokers in Surat.