Psychology of an Investor
Transcript of Psychology of an Investor
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1 INTRODUCTION
2 THEORETICAL PERSPECTIVES
3 APPLICATIONS
4 CURRENT RELEVANCE
5 LEARNINGS AND CONCLUSIONS
AGENDA
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Who is an Investor ?
The Guy who putsmoney into investment
products with an
expectation of financial
gains
Looking to maximize
gains and minimize risks
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Investor Psychology
Social
Cognitive
Emotional
Economic
Decisions
Market
Prices
Market
Returns
Resource
Allocation
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THEORETICAL PERSPECTIVES
Prospect Theory
People respond differently to different situations depending on the context Investors become considerably more distressed at the prospect of losses than
they are made happy by equivalent gains
Investors become more of risk takers when faced with sure losses
Regret Theory A persons emotional reaction to having made an error of judgment
Applicable when - Buying a stock that has gone down; Not buying one they
considered and which has subsequently gone up and when conventional
wisdom is not followed
Anchoring
A behaviour in which, in the absence of better information, investors assume
current prices are about right
In a bull market, each new high is 'anchored' by its closeness to the last
record, and more distant history increasingly becomes an irrelevance
Too much weight is given to recent information
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THEORETICAL PERSPECTIVES
Over-Reaction
A behaviour which is the consequence of investors putting too much
weight on recent good news and hence showing overconfidence
Investors tend to become more optimistic when the market goes up.And Prices rise too much on good news
Bandwagon Effect
The tendency to believe certain outcomes because others believethe same
Keynesian Beauty Contest Model
Buying a particular share because others are buying it
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THEORETICAL PERSPECTIVES
Biases Systematic errors of judgment such as relying on intuition
rather than on the rules of the market
Optimism
Conservatism
OverConfidence
Short TermFocus
Hindsight Confirmation
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APPLICATIONS
FinancialAnalysts
Research indicates thatprofessional analysts are
remarkably bad atforecasting the earnings
growth of individualcompanies
They fail because they liketo stay close to the
crowd; and their forecasts
tend to extrapolate fromrecent past performance,which is very often a poor
guide to the future
InstitutionalInvestors
May be reluctant to take
minimal risk of investingin a stock (whose
probability of successhigh) out of the fear ofbeing fired if the stockdoes not perform well
Similarly, agents tend tofavour well-known and
popular companies
because they are lesslikely to be fired if they
underperform
StockAnalysts
Stock analysts as a group
engage in herd behaviourin part because they are
constantly evaluatedagainst their peers
While forecasting, younganalysts try to go with
the crowd more than the
older ones. This isprobably because a few
notable failures candestroy reputation
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THE INVESTOR PSYCHOLOGY CYCLE
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According to the cycle, a bull market typically starts when amarket is at a low and investors scorn stocksContempt
They try to decide whether what they have left should beinvested in a safe haven such as a money market fund. They haveburnt their fingers with stocks and vow never to invest again
Doubt and
Suspicion
The market then gradually starts showing signs of recovery. Mostinvestors remain cautious, but prudent investors are alreadydrooling at the possibility of profit
Caution
As stock prices rise, investors feeling of mistrust changes to
confidence and ultimately to enthusiasm. Most investors startbuying their stocks at this stageConfidence
Prudent investors are already starting to take profits and get outof the stock market, because they realize that the bull market iscoming to an end
Enthusiasm
THE INVESTOR PSYCHOLOGY CYCLE
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Investors enthusiasm is followed by greed, which is oftenaccompanied by numerous IPOs on the stock market
Greed andConviction
Investors look beyond unsustainably high price-earnings ratiosIndifference
As the market declines, investors show a lack or interest thatquickly turns to dismissalDismissal
Then they reach the denial stage where they regularly affirmtheir belief that the market definitely cannot fall any furtherDenial
Concern starts to take a hold and fear, panic and despair soonfollow. Investors again start scorning the market and once againthey vow never to invest in stocks again
Fear, Panic and
Contempt
THE INVESTOR PSYCHOLOGY CYCLE
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THE SATYAM STORY HUGE FLUCTUATIONS
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Highs and Lows
High Price
Low Price
Satyams decision
to buy Maytasproperties
World Bank bars
Satyam for 8
years
Ramalinga Raju admits
fudging of Satyams
accounts to the tune of
Rs 5000 cr
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I
n
M
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l
l
i
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n
s
Total Traded Quantity
Total Traded Quantity
Highest
traded
quantity ever
THE SATYAM STORY HUGE FLUCTUATIONS
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CURRENT RELEVANCE THE SATYAM STORY
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Close Price
Close Price
SEBI eases buyout
rules
Share Price Rs.
57
Tech Mahindra
won the bid for
Satyam
Share Price Rs.
43
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LEARNINGS & CONCLUSIONS
How is the Economy
Behaving ?
How has the InvestorMatured and How is
he behaving now ?