Emotions of fear, greed, desire and hope are responsible for market fluctuations
Stock exchange is known as the pulse of the economy. While in the long run the share market reflects the economy, there are
various factors that contribute to wide fluctuations in the market movement in the near term.
When the long term and experienced investors analyse any
movement based on fundamentals and take a call to deal with their
investment, short term and new investors are perturbed by wide
fluctuations in a falling market.
Markets always react to news. It may spring out of politics and elections. It may be from war among nations which may affect international trade of commodities. It may be due to excess or short rainfall. It may be a once in a century event like a tsunami or pandemic.
But ultimately the share market will settle down and be stable in the long run, based on fundamentals of the economy and the individual companies. Exceptions may be only when there is political instability in the country.The markets go up and down based on different reactions of individual investors. The sum total of investors decide to enter or exit or stay in the market as a whole or in individual stocks and that ultimately decides the market direction.
We may call the different emotions of investors which make them act or not to act under Desire, Expectation, Fear, Greed and Hope (DEFGH), as ABC of their investment basis. People invest in the stock market with an intention to make a decent return with lesser or moderate risk, which forms the basis for any investment. When an investor buys a stock or an index, he has some expectation that the price of that stock or index will go up in line with the expectation of the investors. After a purchase is made the price may go down contrary to the expectation, which may set in fear to force an exit from the market and cancel his long or short position.
It is possible that after a purchase, the price may go up. The investor feels elated and he may expect the price may go up further though fundamentally it may not be possible. But the emotion of ‘Greed’ sets in, and the investor continues his position, though the price has reached his target. When greed operates, he continues his position even after his target is met.
Sometimes, the price falls after his purchase. But the investor feels that he has correctly identified the stock and he ‘hopes’ that in future the trend will change and he will reap profit. When hope operates, an adverse position is continued.
As human emotions cannot be predicted, for any event, investors across the board may react differently. When there are lakhs of investors with varied emotional traits, it will be simply impossible to predict market movements in the near term.
It is well settled that the market will ultimately reflect the economic fundamentals in the long run. In the meanwhile, there may be a bull phase or bear phase and even the duration of the bull or bear phase cannot be predicted.
Investors who indulge in leverage are the ones who are more susceptible to panic reactions. They may be right also because when they operate with borrowed money, they have to enforce strict ‘stop loss’ orders, otherwise they may be ruined. Investors who invest their own money in the stock market must decide their investment based on the long term economy and use any opportunity to increase their exposure based on fundamentals. They need not operate on the basis of emotions.
Warren Buffett’s statement that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful” conveys this beautifully.
(The author is a retired banker)