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Visualizing investors’ emotions

Investors’ emotions circle around from fear to greed and back again.

Given that investors’ emotions move in cycles from fear to greed and back again, the two obvious questions to ask are “Where are we in the cycle now?” and, as greedy asset gatherers, “How can I make money from it?”

Entire books have been written about slumps and bubbles.

For this post we’re going to make do with a few over-simplified graphics!

Investor’s emotions in graphic form

Note that in the different attempts at visualizing investors’ emotions that I’ve collected below, you won’t find any shots from charting tools or similar

While I’ve no doubt that investors’ emotions do cycle, I’m very doubtful that most of us can take short-term advantage of it through charts. So no double-tops, candlesticks, death crosses or any such bric-a-brac here.

Rather, the main benefit to understanding emotions and investing is to know yourself better.

Once you appreciate how psychology moves the markets, it should help you stick to your plan, whether it be passive investing or more hands-on stockpicking.

Greedy buying, fearful selling

Nobody is immune to the cycle of fear and greed. Even the greatest investor can get carried away, or else be made miserable by a deep market downturn.

From euphoria to despair

When I wrote that I thought the markets were an absolute buy in March 2009 for anyone who was ever going to buy shares, I got nasty comments across the blogosphere.

I don’t mean “yeah, perhaps, but I don’t think he’s right”. I mean suggestions I was part of some secret narco-government backed plan to ramp up the market to make the last few people with any cash insolvent.

The nicer ones just said I was an idiot.

That’s what the bottom of a bear market looks like. (While I was confident it was a good buying opportunity, I won’t pretend to have known the subsequent big rally would come so swiftly!)

Nobody rings a bell at the top

This is the same graph as above, really, but I like how the creator has put in the shaded areas. This stresses that there’s a phase of euphoria and of despair, rather than a single event that marks the top or bottom.

Where are we as I write in December 2010? I’d guess we’re somewhere between hope and relief. If I’m right, then the masses who are still waiting for an optimistic mood before buying will pay a steep price in forgone returns.

It’s less risky to buy something unwanted

It’s better to buy an asset nobody wants, mainly because you’ll get it cheap. If it’s cheap, there’s less far for it to fall, as well as much higher for to climb.

Elementary, you’d think, but for some reason people like to buy expensive. Just ask my friends, who almost to a man1 shunned my suggestions to invest for the long-term in the 2008/2009 bear market.

Nothing new under the sun

This is clearly just the chart above, jazzed up for a fund manager’s literature.

What’s interesting though is the date. This chart was created in 1998. Just two years later we saw the mother of all stock market bubbles, and nine years later one of its fastest and most frightening slumps.

If you’d seen this chart 12 years ago, wouldn’t you have been better placed to ride through that rollercoaster?

Little ups and downs add up

I like this graphic because it includes lots of jagged lines. The other charts make riding investors’ emotions look as simple as going up and down on a see-saw, but in reality it’s a lot tougher than it looks.

Is any particular zig the start of a new leg-up, or is it the last gasp before a zag down into a slump? Very hard to tell until five years later.

Funny old investors, and their emotions

(Click to enlarge)

I am pretty sure I first saw this graph during the dotcom boom. It’s been regularly wheeled out ever since.

No wonder: Whoever knocked it up all those years ago knew everything you need to know about investors’ emotions, and had clearly been around the block.

In fact, I wouldn’t be surprised if he or she had said these things themselves!

Books and blogs are reasonable teachers, but nothing beats living through a cycle of fear and greed to really understand sentiment and emotion in the market.

  1. The women have been smarter, and kept dripping money in []

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{ 5 comments… add one }
  • 1 Alex December 23, 2010, 6:56 am

    1. Thanks for a great article. TA’s previous post segues into yours – nice continuity.

    2. Those graphs are instructive. However, I think we need to distinguish between graphs of a given price vs time and those of mood vs time.

    3. Regardless, each of those graphs only relates to some period of time – in isolation from the past. Yet it is surely useful to know the history: ‘how did we get here?’ Knowing this helps us to contextualise the present.

    4. Turning to the present: I am reassured that the UK mass media doesn’t seem to be too interested in the recent strong performance of the FTSE 100 index. Hopefully we really are “somewhere between hope and relief”…

  • 2 ermine December 23, 2010, 11:59 am

    > but nothing beats living through a cycle of fear and greed

    You have to lose your shirt at least once to have any chance of getting it right. That’s probably necessary to learn discipline, though not sufficient. Plus the bad habits tend to creep back over time. The dot-com bust is hopefully recent enough for me, with a quick refresher course with BP’s woes 🙂
    .-= ermine on: asset allocation review part 2 and passive investment =-.

  • 3 Salis Grano December 23, 2010, 9:55 pm

    Lovely set of graphics. I like the jagged chart best since just drawing a sinusoid with mood labels does not tell you much. Something that approximates to a real market is potentially more instructive. My favourite is the Rodrigue chart, which although much smoothed, includes similar bear and bull traps (i.e. “aversion” and “buy the dip”). These are the real problems areas for the investor.
    .-= Salis Grano on: Mistakes You can Afford to Make =-.

  • 4 Financial Samurai December 26, 2010, 2:13 pm

    The question now is, where are we now in the cycle? Everybody seems to be quite bullish about the markets in 2011. Would you agree?
    .-= Financial Samurai on: 5 Reasons To Include Annuities In Your Estate Planning =-.

  • 5 The Investor December 26, 2010, 2:50 pm

    Hi Sam. Well, as I say I think we’re just on the way between ‘hope’ and ‘relief’ on the emotional rollercoaster’s upswing stage.

    Stock markets still look reasonably good value to me, given reasonable expectations of earnings growth. Not the screaming buy of early-2009.

    Of course, anything can happen in 12 months in stocks or even over five years, so I don’t believe these things are inherently predictable. But I do think that’s the emotional backdrop.

    Most non-enthusiasts still seem frankly terrified of stocks to me.

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