When I decided to study Economics, there were not many options to choose from. It was a good career, it would allow me to work in different kind of jobs, it was not restraining. What I didn’t know at that time, was that I was going to use Psychology all the time. And I love Psychology!.
We are humans, and we interact with humans. So we have to understand human behavior. While studying Economics, my favorite subject was Behavioral Economics and when I finally started doing something I am passionate about, I use more Psychology than anything.
The investment cycle is ran by humans. Human behavior is reflected in it.
The following diagram shows the investment cycle and all the emotions experienced throughout it.
Source: AM Global Family Investment Office
Nobody makes a researched investment thinking it will be a bad investment!!! You are full of optimism! And that is great! When it goes up, you experience excitement, thrill, and euphoria. But as everything in life, investments get to a plateau.
This plateau is what we call the POINT OF MAXIMUM FINANCIAL RISK. It means, that from that point forward the investment will go down.
Sooner or later (nobody can tell you the exact timing) it will go down. If you have not SOLD the investment before this point, then you will go down with it thorough emotions of anxiety, denial, fear, desperation, panic, capitulation, and despondency.
Then you reach the point of MAXIMUM FINANCIAL OPPORTUNITY. Is the point at which you should BUY.
The price of the investment will be low enough that the only way to go is up again. You will go through depression, hope, relief and finally get back to the initial point of Optimism.
How to avoid the downside of the curve is key in an investment strategy, here are some guidelines:
AVOID “THE HERD”:
Do not buy because others are buying or sell because others are selling. We should buy because there is value in what we are buying.
BUY FROM THE FEARFUL, AND SELL TO THE GREEDY:
Try to take advantage when investors are behaving irrationally.
DON’T GET DISTRACTED BYSHORT-TERM “NOISE”:
Making investment decisions based on market trends or the latest news leads to potentially catastrophic losses. Focus on long-term investing across full market cycles.
Just think about your own emotional cycles in anything you do. Don’t they look just like the above diagram? They do. We are humans. Humans are ruled by emotions. And emotions are reflected in the investment market.
The next time somebody tries to sell you and investment, think in which part of the cycle the investment is.
Is it a super hot stock, which may be in the pinnacle of the curve? How long will it stay there? Or is there still some way to go until we reach the top.
Maybe is an investment that is performing badly, but when you see the numbers of the company behind it, they look ok. Maybe is just the emotional factor going through a depressing phase, but there is nothing wrong with the investment. Maybe is the time to BUY.
Discuss this with your banker, investment advisor, or whoever helps you with your investments, and always learn everything you can before you invest.
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