Know investor behaviour to ride the market boom

Stock investing is driven by emotions such as greed, conviction, fear, and pride, causing psychological biases. The two most common investing mistakes are - unwillingness to sell stocks at a loss, despite sell signals (loss-aversion bias); Wanting to buy multi-baggers but unwilling to invest in them, thinking that it is expensive. Such stocks at any given point trade near 52-week highs.

Have you bought value stocks (e.g. Suzlon Energy, Kingfisher Airlines, etc.) at a bargain and refrained from selling on the expectations that it will go up and eventually incurred bigger losses? (regret-aversion bias). How about not buying stocks that double in market-cap thinking that it is too expensive and late to enter? Only to discover that it has surged further? That is a bias right there. Eicher Motors, for example, scaled Rs 5,000 in 2014 and Rs 20,000 in 2015. It currently trades at Rs 28,000. Numerous stock winners such as Page Industries, MRF, Gillette India, display similar price movement. An expensive stock in numeric-value terms may not be overvalued at all. It can continue to rise/fall, based on other stock indicators that matter.

Stock investing is not an exact science; it is nuance-galore. The use of empirical rationality is limited. There is room and need for subjective interpretation. We all have biases, which gets extended to investing as well. When hard-earned money is invested, and there is so much to lose; biases are inevitable.

So, how to deal with the inevitable?

Behavioural finance researchers have expounded scores of human investing biases; including, herding bias, anchoring bias etc. The first step is to be aware of your biases, acknowledge them, and then overcome the biases through learning and practice. Along with fundamental analysis, technical analysis comprehensively explains buy and sell points. A rule-based investing method that considers fundamentals and technicals in depth can help investors as it negates psychological biases, and focuses on stock indicators that matter.

Some of you may be familiar with chart patterns such as cup-with-handle. What gives rise to such patterns frequently in the first place? Why does the 50-DMA act as a strong resistance level? Chart patterns are actually a summation of human psychological actions of the past and present. The repetitiveness of the shapes occurs due to similar investing behaviour in different scenarios. The clichéd saying – history repeats itself – is true in markets. Shrewd investors continue to make money by understanding stock market psychology.

The writer is COO, William O'Neil India.