12.1 Investor's psychology

Hanumant Dhokle

STOCK MARKET AND INVESTOR PSYCHOLOGY

Let us discuss the psychological factors which influence investments in stock. There are several factors which influence the investors, based on their income, age, sex, region, access to technology, and others. However, two important factors that influence investor’s behavior the most are:

  1. Greed
  2. Fear and Panic

What Is Greed?

Usually most of us want to accumulate as much wealth as possible in the shortest period of time. Greed is the excessive desire to possess something instantly. This greediness prevails especially when the markets are bullish. This happened with many investors who started investments in 2004 and 2005 and became rich as their investments multiplied by two, three and even four times. At this point, they were reluctant to book their profits as they felt prices would go further up, making their investments appreciate by ten or twenty times. This behavior prevailed even when the Sensex touched an all-time historic high of 20,000 and was sailing towards 21,000 till January 2008. From that high level, the Sensex nose dived to 7,500 levels, and the greedy investors realized their mistake. The lesson the investors should learn from this is that investments should be done and managed according to the investment objectives and plans, and not out of greed. If the investors want 50 per cent returns per year, stocks should be liquidated once this objective is attained. If the investor feels that the stock price would go up further, then it is advisable to book partial profits, which means selling half of the investments or even more. An example of greed extracted from the DSIJ Stock Market Book is given herewith.

Suppose you bought stock of XYZ Company. If the price of the scrip increases, you are overjoyed and would take pride in making the right selection. The price of the scrip has already appreciated by almost 50 per cent. The scrip, then, rises by almost 100 per cent. It does not stop there. The price now rises further and further to 300 per cent. If, now, somebody tells you to book profit, you will look down upon him as a fool. The price goes up further, say by almost 400 per cent. You are euphoric and advise your friends also about this scrip. You expect the scrip to rise further.

Now, you may regret why you had bought only 500 shares in the first place. You start thinking of investing even on the current price, which is 500 per cent higher than the price at what you had initially bought. This is the point where you are gripped with the greed factor. This is because you are not even in a position to consider a professional suggestion that the scrip is overpriced. Continuing the earlier example, when the price appreciates to 400 per cent, which is also beyond your expectation, you still do not wish to part with the scrip. You have gone through the quarterly results of the company and you expect the fourth quarter to be better than the third. The CEO of the company in the third quarterly results announces that the earnings for the fourth quarter would be much higher. You trust the statement and decide never to sell the scrip. Here, you are under the influence of greed. This is where you are making a mistake. The following table shows how majority of investors were under the grip of greed during the IT boom in 1999-2000.From the table you will see that if an investor had sold his share in (a) Mar’00 (b) Apr’00 (c) Sep’00 months, he would have made good profits. But the investor, who under the influence of greed, had decided not to sell, made losses.

PRICES DURING THE TWO YEARS
NAME FV MAR APR SEPT DEC JAN MAR JUN
INFOSYS 5 13931 8950 8949 8041 6939 6350 3995
WIPRO 2 7700 5940 3470 3099 2991 2640 1774
SATYAM 2 1454 9692 646 407         430 352 228
NIIT 2 2629 2230 1945 1924 1812 1275 512

Here is another example

Mr A decides that he will not sell his shares as the prices are going up and thus he falls in love with the scrip. But, even after the announcement made by the CEO of the company that the next quarter results will be better than the current quarter, the share witnesses a meager 5 % rise the very next day, rather than a 25 per cent increase as expected by Mr A. He consoles himself thinking that it may take some time to rise from the current level.

In the following days, the price of the scrip fluctuates between 5 to 10 per cent. Mr A has seen the price of the scrip at Rs 500 and he thinks that the scrip is settling on this price and then will move up again. Suddenly, there is bad news. The price drops to Rs 400 and the first thought that crosses Mr A’s mind is to sell the scrip. However, he wonders why the scrip has dropped though there had been a good article in the newspaper pertaining to the CEO’s statement and future outlook. Several days pass and Mr. A finds that the scrip is slowly declining. He decides not to change his opinion in regard to the newspaper article and holds on to the scrip. He phones his broker who tells him that a significant increase in the scrip’s price in the recent past has led to profit t booking by a few select investors.

For a brief time, Mr A thinks about selling but decides not to do so till the scrip’s price touches Rs 500 again.

After a few days, he finds that the scrip’s price has fallen to Rs 300. He feels the pinch about how a few big investors are hammering the price of the stock down so that they can buy it at lower levels again, thereby making a good sum of money. Therefore, Mr A thinks that it is going to be a temporary phase. Mr A now waits for the price to go up but, on the contrary, it slides further down. He tells himself that this decline in the prices is mainly due to profit t booking in the counter. He continues to have faith on the CEO’s words.

The very next month, the price of the scrip drifts below Rs.300. The company’s quarterly results add to his anxiety. The result shows a meager 5 per cent increase in the bottomline as compared to the expected 25 per cent. Very soon, the price of the scrip declines to Rs 250. Mr A has mixed thoughts. On one hand, he feels he still has a good profit to take home. And, on the other hand, he feels the next earnings’ report will be much better.

He feels it will be foolish to sell it at this moment and lose the additional profits if the scrip starts moving up again. He struggles to reassure himself that the price will not fall below Rs 100, this happens to be his cost of purchase. The next morning when Mr A opens the financial newspaper, he finds the price of the scrip has gone down further.

At this point, a friend advises him to sell the scrip at least at the current price levels as there is still a possibility of making a 100 per cent return on his investment. But, he disregards this suggestion. He waits for the next quarterly results. The quarterly results, however, get postponed. To add to his woes, Mr A reads in a leading financial daily that the SEBI is investigating the sharp rise in the price of the scrip from the very beginning. Simultaneously, he reads a few more news items which indicate that the government is reducing the custom duty on certain products, which is the main business of the company. Mr A calls his broker who informs him that there are only sellers in the street and no buyers for the scrip. Currently, the scrip is quoting at Rs 60. He feels desperate. Mr A panics and tells his broker to sell the scrip at whatever price. Finally, his broker sells it at Rs 40. So, one can see that at one point of time, Mr A could make a profit of Rs 20,000 on an investment of Rs 5,000,but now he has to bear a loss of Rs 3,000. This is the highest influence of greed. Similar situations have existed in the history of stock markets world over. And, you will identify many scrips which rose to their highest level from rock bottom prices and in few months or a year’s time fell badly to their original destination.

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