Wednesday, August 3, 2011

Behavioural Psychology and Investing: Be Aware of Investor and Stock Market Expectations.

Behavioural Psychology and Investing: In his book “The General Theory of Employment” renowned economist John Maynard Keynes devoted a wonderful chapter to investor expectations. In the book he notes that investors are generally concerned “not with making superior long-term forecasts of the possible yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.” The basic premise of his theory is that in determining the value of an investment, a lot of fundamental and intrinsic value analysis can be a waste of time when all that really matters is what other people, on average, will think that the stock is worth over the next few months or years.

Of course, if you were buying the whole company, the most important thing to you is going to be earnings, and future earnings, because that is the money that you will put in your pocket. As a short- term investor, however, you only want to know what other people might pay for your stock over the next little while. In this case, the emotion of the investing public plays a crucial and pivotal role. Investors like Keynes have been highly successful at times by trying to predict the emotions of the general public and how this will affect the price of securities.

One very simple, but sometimes very effective strategy is to always buy your stocks on pessimism and sell into positivity. Remember, if everyone is already positive on a stock that means that there might be very few new buyers. If people are largely negative, a shift in company news or opinion could result in a stream of new buyers. Also, if you own a company whose shareholders have high expectations, be careful at the first sign of bad news... it could mean a stream of new sellers. As Warren Buffett always says “Be greedy when others are fearful, and fearful when others are greedy.”

Happy Investing : )

1 comment:

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