How Investors react in different market situations

We all are born with some instincts. Some of them can be changed and some can’t. Investment attitude is reflection of our basic instincts. It would be better if we could know our own investment attitude, behavior and style. There is nothing wrong in diagnosing ourselves. Knowing the category we fall into, we may devise a strategy to have maximum benefit of it.

People say market moves in cycles – yes, but it is cycle full of emotions. This cycle combined with the response that you get on your emotions decide the losers & winners.

How Investors react in different market situations 1

Now let’s attempt to know how behavior was responsible in the last three years. The data in study is the BSE Sensex movement from September 2007 to September 2010. These 3 years were a good ride for sentiments but the bigger question is, has investor and particularly the equity investor has learned something or not? If we would have taken this graph from 2000 this would have been almost same in many ways. To simplify things we have sorted out the 4 main emotions or the situations.

  • Thrill & Euphoria
  • Anxiety & Denial
  • Fear & Panic
  • Relief & Optimism

There can be many more emotions but we have not touched them – similarly as we can’t find the tops & bottom. We have shown that how different type of investors react in different situation – you can check is it you.

How Investors react in different market situations 2

How different investor reacts

Before Going Further quickly check: Type of Investors

We start with best time of market – but were it really the best time – depends on what type of investor you are.

How Investors react in different market situations 3Thrill & euphoria (cycle starts where optimism converts in excitement)

1st Sep 2007 to 14th Jan 2008 – in 4 months Sensex jumped from 15300 to 21000 – almost a 40% rally in these 4 months.

  1. Window Shoppers: Finally again the cheating has started…. No worries it will fall to 6000 levels… then see….He is actually saying this thing from 2005
  2. Seasonal Traders: Hmmm…RNRL & RPL looks good – instead of getting into cash market I will trade in futures… let Reliance Power get listed, my stocks will double. TV channel says Parsvnath is good with an upswing of 40% plus… let me add a lot of this one too…. Midcaps also look mouthwatering…
  3. Scapegoat: My agent had said that equity will give returns…. He was right…. Good analyst…. Again this time he is saying it will cross 25000 levels…. And asking me to invest in NFO of an Infrastructure fund… ok done, let’s invest…
  4. Hi-tech Lalaji: This is great time… I have made smart investments – but now, I don’t have surplus money… why not get leveraged….. Let me earn on somebody else money …smart…. Let me get a funding in Reliance Power IPO. These pink papers and journalist are all crap other wise why would they come to office so early and tell me where the returns are? Market is operator driven game….. I get tips from horse’s mouth ie from Mumbai…
  5. Mr. Cool: Equities are not good or bad it’s the price you pay that makes the difference. Indian story is good but the way things are moving are not good. PE ratio doesn’t justify the present level. Read in news paper that 1000 stocks are in upper circuit from last 7 days – fundamentals have not changed much. News from global is not good. Let me sell those stocks which are way ahead of fundamentals.

How Investors react in different market situations 4Anxiety & Denial (euphoria ended & markets started drifting down)

On 22nd Jan Sensex touched bottom of 15300 (same where it was on 1st September) – but this comes as a falling knife, almost 30% down in 10 days. On 4th February Sensex touched 18900. But midcaps/small caps were butchered.

  1. Window Shoppers: …. I told you……see…. and mind you this is the BEGINNING…
  2. Seasonal Traders: What is this …..? Broker axed my lots… he auctioned my investments without informing me…. But market will have to rise…. So I got money from my friend circle and invested…. Will repay when I recover my investments.
  3. Scapegoat : Agent is saying that the correction phase is over… lets invest more to average the losses….so investing in lump sum as this is the best time…. He is the mutual fund expert and can’t go wrong.
  4. Hi-tech Lalaji: Portfolio is down but Mumbai wale said to accumulate as recovery is round the corner…. Let me do one more thing…. Let me also get funding over the mutual fund investments too…. Earning on somebody else money has different feeling all together.
  5. Mr. Cool: I was right but still valuations seem higher. Let me get some positive cues and till then I should wait & watch before participating.

How Investors react in different market situations 5Fear & Panic (Market started drifting down)

In starting of August 2007 Sensex was still hanging at 15600 levels – but worst was still to come which very few anticipated. In one and a half month markets tanked – On 27th October 2008 Sensex touched a low of 7697. From highs of 21000 it was down by 66%. Midcaps & small caps were down almost 80-90%.

  1. Window Shoppers: That’s the reason I don’t invest much in equity (sour grapes)…that’s why I withdrew my investments at 21000. Wait sensex to go 3000 levels.
  2. Seasonal Traders: Oops I made a small silly mistake…. I should have short sold instead…. On TV they are saying it will go down more… so if I short sell now I would regain losses….. Let’s do it.
  3. Scapegoat: Oh my God…. What sin did I do…? Papa was right that equity is gambling. …. My mutual fund agent has disappeared as he is not even picking phone…. Let me call somebody else and withdraw. Also I am stopping all SIPs….. Will open a post office RD instead…. Now I swear to God, I will not invest in stock market.
  4. Hi-tech Lalaji : This time Mumbaiwala went wrong… but that’s ok… my turn will come again than I will recover all in one go… also he lost more money than I did… do you have a capital protection fund that protects capital but participates in upside?? Just got a call from a PMS Manager… he made 100% return in bear phase…. Let it settle than will invest some here…
  5. Mr. Cool: It’s a great time to invest in good companies. Whether the company is bad or good but the prices have come down for all…. This is the time for value buying.

How Investors react in different market situations 6Relief & optimism – Investor had seen the worst he could have seen. Still the pain was left and many investors had already made up their minds not to look at stock markets again.

Market started rising slowly but investors were redeeming money at every rise – The rise was slow but consistent. Then come THE DAY – Parliamentary Election results were out. Against the general perception of a hung parliament, Congress came with majority. 18th may 2009 turned one of the best days for the equity markets (may be not so good for short sellers) – market hit the upper circuit & trading was suspended.

  1. Window Shoppers: I have purchased whatever I wanted to (sourest grapes)… I never cared the market direction… I always buy cheap as this gives the best returns.
  2. Seasonal Traders: This time market taught a good lesson… next time I will not repeat what I did this time…. By the way which is the next IPO…? Should I invest in gold…? This is safe… let me buy a one lot of it.
  3. Scapegoat: Mutual fund is risky…. The agent’s son has taken a life insurance agency…. And he was talking about highest NAV guaranteed plan…. Concept looks good… will invest a bit here.
  4. Hi-tech Lalaji: Do you have some product exclusively for HNI’s like me… Just heard from Mumbaiwala friend that there is of lost money in Private Equity and Venture Capital funding…. Mutual fund are slow in rising… do you have a product where I can cash on returns of property market in Dubai.
  5. Smart investor: No reactions… it was a normal warm shiny day for him. Enjoying his life with family and planning for a holiday.

A mentally relaxed person generally opts for long term investment, waits patiently for investment opportunities, and doesn’t take investment decisions in a hurry. Contrary to this, an overconfident person takes investment decisions in a fraction of a second, assuming that he is the only person  privy to secret details about that investment avenue, changes his own decisions a moment later, incurs loss and feels confident to recover the loss the very next moment. So keep your head cool & think wise.

This article is part of “What Investors Really Want” E-book Download & read the full Behavioral Finance Guide from here and be a sensible investor.

Hope you learned something from this article – Must share your views.

16 COMMENTS

  1. Excellent article Hemant! You have captured the mindsets of typical Indians.
    And again another pointer to the fact that Equity is not just Gambling, but it’s scientific and rewarding if approached in the right way.
    I will send the link to this article to my friends.

    Regards,
    Shinoj Jose

  2. Dear Sir,

    Really enjoyed reading your observations in different of market-moods and how people react thereafter.. Once I had been a short term trader and now turned into a long term investors for the last twenty years. I really benefited from being an investor. Sir, I just wanted to ask you one thing- how can one protect his portfolio in this type of unpredictable market by choosing the derivative-tools.

    Satnam

    • Hi Satnam,

      It’s good to hear that you are a long term investor from last 2 decades. There are sophisticated tools like put options but I don’t think there is much benifit of using it.

      First we don’t what is high – you are saying “protect his portfolio in this type of unpredictable market” but you can be wrong if market start rising or stay where it is for prolonged period. What will happen in this case you just keep paying 2-3% premium on hedged portfolio.

      I believe in simple asset allocation strategies more than anything else.

  3. What else can I say, it just reflects what most of us experienced during those turbulent and elated period of indian investing! Right on the dot. Well done Hemant.

  4. Dear Hemant,
    The write-up very rightly catches the pulse of an average Indian investor in various equity / market cycles.
    Majority of layman invetsors in India adopt the self-medication theory rather than consulting a good doctor (certified financial planner) and go for over the counter avilable options for a short -term reprieval of the pain rather than curing the root cause.
    Inspite of mutual funds being the most transparent , disciplined and least costly investment tool, it’s the least discussed, advised and adopted method of investments in India.
    We do need more of such initiatives to teach and reach invetsors with genuine information on the right financial products.
    Congratulations and keep it up!!
    Regards
    Saket

  5. I am quite sure a lot of retail investors would eneter markets at 21000 levels when media would be pouring news with Sensex target of 25000 in near term

    • Hi Mayank,
      This happens every time – but let’s not give any figure to market. May be next time when we cross 21000 – it’s just beginning of the bull market.

  6. Wonderful & Insightful Article! I am in the process of learning & transitioning from ScapeGoat to MrCool. Thanks for the fantastic coverage across cycles/emotions. I have to bookmark this page to visit ever so often.

    • Hi Newbie,
      In this case you must share this article with all your friends 🙂
      You can also download full guide from top of this page.

  7. Hi Hemant
    Direct investment in equity market is not my cup of tea.I prefer to invest in mutual funds via SIP route.Whenever market tanks I make small lump sum investments in mutual funds.

  8. Hi Hemant,
    excellent article. MF route seems to be the safest way to investing though returns are not as much as stocks. how about investing in a few stocks for the long term if the fundamentals and the management is really good? after the Satyam scam, now it is HLL and Infosys going down ( last 3 qtrs have been bad), so stocks are raelly dicey, I guess. your views pls. regds.

    • Hi Shreedhar
      Higher returns are linked with higher risk.Ultimately every thing depends on your risk appetite.

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