Cycle of Market Emotions

There is no getting by our emotions at any time, especially when it comes to investing. The same brain chemicals and responses to kittens (friendly), or mountain lions (fear) right in front of us in our yard, happen when we look at our investments.

We forget the big picture though. So … here it is:

Notice the greatest risk is at the top of the emotional cycle because that tends to correspond to market peaks as well. The opposite occurs at market bottoms. Although the cycle is depicted smoothly here, what happens with our behavior though, from the market trough it takes some time to begin to believe growth is real and sustainable. At some point, the belief takes hold and quickly changes after that to relief and euphoria. From the peak, the changes tend to be sudden and shocking leading to the carefulness I just described.

What’s the secret then? Establishing a realistic asset allocation based on prudent principles and global allocation (which reduces the risk your portfolio goes to zero; although it still goes down in value – it goes down less). For some, this realistic allocation may be a bit more aggressive, and for others it may be a bit more conservative. The key is that is is something you can live with, not your neighbor or water cooler conversationalist.

What else can you control? Your plan … which by the way, should include the reality of market ups and downs.

Remember that market declines in general to 5% are considered “noise,” 5 to 10% are called “dips,” and your emotions may be getting the best of you over noise and dips … (10 -15% are considered “moderate corrections,”  15-20% are “severe corrections,” and over 20% is called a “bear market.”) Bull and Bear Markets are defined as general market trends either up or down. Funny, nobody gets concerned when things seem to be going well.

See also Panic? Why?

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