Switch in Our Brain !
Sadly we don’t have a switch in our brains – for us to turn it from optimistic to pessimistic, and from bullish to bearish !
And equally sad part is that we’re not trained in behavioural-finance that is as critical as any other tool for successful investing journey.
(Balancing your pessimism/optimism in bull/bear markets is a great skill but it is easier said than done .Problem with masses is that they tend to be on extreme ends at one point of time- either greedy or fearful .That’s why markets move like a pendulum -from euphoria to pessimism and then back to euphoria.)
Recency bias too plays a significant role . While coming out of a bull -market all the great stories of recent past play a role on our minds – our eyes get trained to see the breakout stocks & we tend to start believing that corrections last only for short periods and they are good opportunities to buy on the dip .
We tend to forget that not all corrections are short-term corrections , some corrections happen to be deep and for very long term .Some corrections happen to be beginning of long bear markets and darkness becomes deeper as we move along.
Switching the mindset to the other side becomes harder as we tend to become complacent when the path we’re following looks familiar , the trend becomes a friend and the events around us tend to be aligned with our exepectations.
We humans are very good at forecasting the future, except for the surprises, which tend to be all that matter.
Now it seems that we’re entering a bear market zone – and it is difficult to gues how long it would last !
Key point at this transistion phase ( from bullish to bearish) is whether we’re ready for our brain to transit to this low or zero return zone .
The point is to be prepared. The biggest risk is always what no one sees coming.
If you don’t see something coming you’re not prepared for it. And when you’re not prepared for it its damage is amplified when it hits you.
At this juncture ,preparing our minds to the probability of a long low -returns period might save us from certain hidden risks,can help us calibrating our future expectations.
This is also a good time to remember what Howard Mark wrote in his 2016 memo ( On the Couch ).
He wrote, “in the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless.’”
Let’s help you by giving some insights about the bear markets ( situation turning from flawless to hopeless) ,that might help your brain in the transit phase , in case it becomes a serious bear market.
Bear Markets -Key Charcteristics :
i) Counter -Trend Bounces/Rallies
Bear markets don’t imply that the prices of your stocks won’t rally upward in between.
The deepest bear markets have tended to produce the largest and longest bear market rallies.And sadly there is no sure way to identify a bear market rally in advance as such until it unwinds.
And most of the bear market rallies (counter trend bounces) happen to be fast and ferocious . Markets want you to belive that we’re back in upward journey.
And that’s where your money gets sucked .You recncey bias and success of buying-on-very-dip in bull markets tempts you to deploy fresh cash. And then you get the hit.
These counter-trend bounces in an ongoing bear market are treacherous for investors who mistakenly tend to think that the downturn is going to end. As the primary bearish trend reasserts itself, the disappointment of those who bought during a bear market rally leads to drive the prices to new lows.
“Lack of FOMO” happens be one of the most important investing skills (behavioural finance) – although during every phase of the market but it is much more critical during counter-trend rallies.
ii) Slow Bleeding
Bear markets fall are quite unlike as compared to black-swan events crashes .Black-swan events related falls are sudden e.g. at the time of Covid, demonetaisation as well as when whenever there’s a sudden war. Recovery from these sudden falls happen to be quicker in most of the cases .
But bear markets are result of some cyclical changes in overall economic -factors. They are slow and grinding .And the falls comes in waves . When you feel that markets have gone down enough, they tend to fall more.
The following charts show the waves of falls in the past bear markets of USA .
iii) Re-set Benchmarks for Valuing a Business
One needs to set new benchmarks of PE ratios, market cap to revenue mutiples need to recalibrated, EV to EBIDTA needs to be adjusted new standards..
Old standards of valuing a business in a bull-market are not applicable to the bear-markets.
iv) Phases of a Bear Market
As per Investopedia , there are 4 phases of a bear market
- The 1st phase is characterized by high prices and high investor sentiment. Towards the end of this phase, investors begin to drop out of the markets and take in profits.
- In 2nd phase, stock prices begin to fall sharply, trading activity and corporate profits begin to drop, and economic indicators, that may have once been positive, start to become below average. Some investors begin to panic as sentiment starts to fall. This is referred to as capitulation.
- The 3rd phase shows speculators start to enter the market, consequently raising some prices and trading volume.
- In the 4th and last phase, stock prices continue to drop, but slowly. As low prices and good news starts to attract investors again, bear markets start to lead to bull markets.
v) Quick Money on Short side
You make quicker money in bear markets if you are on short side – because pessimism is contagious ( like COVId ) – everyone gets it at the same time and market falls faster.
But for crowd to become optimistic,it takes time , it is gradual , people want proof ( that’s why retailers (masses) buy at the peak of the markets when every proof of upside is already there ). So upward movement is rather slow as cpmpared to dowside -movements.
Don’t Run Away
Replace Your Emotions With A System
Market is more of a brain and liquidity game – earlier (in the cycle) you understand it , better you would be .
Don’t go buy media that talks about SIP in falling markets etc etc , that is for average people .Don’t buy on the basis of your gut -feeling or something looks cheap.
Have a time-tested system or method for entry and exit , a system that suits your temperament, your risk-taking ability & appetite as well as your stage of life. For example, we follow Stage Analysis technique to enter and exit the stocks we love.
You can click here if you also want a simple rules-based method.
Rules and discipline helps us to overcome our emotional -biases as well as helps us to ignore the noise around us.
Summary :
Let’s try to imagine that we have a switch in our brains. But that switch can only work by going with the trend – switching the sides is the key – remember you are not on a ego trip in this market but you’re on a money – making trip – change your views when the underlying facts change – don’t be rigid , be like water – formless , shapeless ,egoless and long-term opinionless – go with the wind my friend .
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