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19 Jun 2021 5:56
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  •   Home > News > Business > Features

    Markets are darkest before the dawn

    The markets have been exceptionally volatile. When you see the Dow Jones slump by 7.5% in one day, only to recover the next, you are witnessing very rare circumstances.

    Investment Research Group
    Investment Research Group
    We have seen investors move from concern to fear to outright panic, and then back again. This is a good thing. Such panic is an inevitable and necessary part of the shakeout of the greed and incompetence that has afflicted financial markets for the past decade and means we are getting closer to when smart investors can start buying.

    However, the time to buy may not yet be upon us. One telling sign of a turnaround is when some shares begin to move against the market trend, rising in price on increasing volumes.

    That is a sign of 'bottom feeding' by the brave and clever.

    Timing a market is extremely difficult, though, which is why many pundits believe you should never be totally out of the share market.

    When it comes to market trends, one should always remember that they are not the great beasts they appear. A market is made up of lots of trades by individuals, all of whom are afflicted by emotions, instinctive behaviours and various degrees of intellectual capacity.

    Therefore, by understanding what motivates other investors - particularly those in the broking firms, investment banks and institutions which make the bulk of market trades - you can avoid repeating their mistakes.

    Humans react to an event in very similar ways and it is possible to anticipate their reactions. Funds management company RMB has distilled these reactions into an analysis of typical thought processes of individuals and therefore markets.

    The process goes like this:

    Contempt: A bull market typically starts when a market is at a low and investors hate and avoid shares.

    Doubt and suspicion: The market starts to pick up but most investors remain unconvinced and continue to hold other assets like cash.

    Caution: The market gradually starts showing signs of recovery. Most investors remain cautious, but prudent investors begin to buy shares.

    Confidence: As share prices rise, investors start feeling more confident. Most investors start buying their shares at this stage.

    Enthusiasm: During this stage, people who do not normally own shares begin to buy while prudent investors start to take profits.

    Greed and conviction: Investors become increasingly addicted to quick profits and sometimes this leads to a bubble where almost everyone believes the market will rise indefinitely.

    Indifference: Investors show no interest in typical measures of share value, such as price:earnings ratios or yields.

    Dismissal: As the market starts to decline, investors believe it is a temporary lull before the next period of sustained rises.

    Denial: Investors act on the belief that the market cannot fall any further.

    Fear, panic and contempt: Concern starts to take a hold and irrational gloom and panic soon follows. Investors again start spurning the market and vow never to invest in shares again. This leaves the door open for the beginnings of the next bull market.

    That time is not now but it is important to remember during these hard times that one day there will be a bull market again.

    © 2021 David McEwen, NZCity

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