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Why People Lose Money in Stocks: Cycle of Emotions in Trading

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Here’s one interesting thing about stock market investing which I learned from my finance professors in school: The number of conversations about stock trading is directly proportional to the growth of the stock market.

What does that mean? You’ll notice that as stocks go through a phase of bullish periods and highs, more and more people start talking about stocks and stock investing. Thus: The number of conversations about stock trading is directly proportional to the growth of the stock market.

We’ve seen this in the case of the Philippine stock market when its bullish run started 2-3 years ago.

The average person becomes a “stock market expert” — talking about how much he has made money in this or that stock. Several people — whose background, experience and expertise we do not know — emerge and market themselves as “stocks guru” offering investing and trading advise here and there.

You’ll know we are in this optimistic stage when news programs that usually focus on politics and entertainment (sometimes the same content in just one report) insert segments about stock markets and how the average person can make money in stocks.

Emotional-Investing

‘Market Surge’ phase: Optimism

Welcome to the “Market Surge” phase of the Cycle of Emotions in Stock Trading.

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In this phase, almost everyone is optimistic because all stock picks have been good picks, generating consistent returns month after month. It seems stock losses are a rare occurrence.

During “Market Surge”, stock prices continue to rise, and the average investor starts to believe he is an infallible stock investor. Indeed, almost all his picks have made him money — and to his surprise, even those stocks and companies he has not heard of have been producing enticing returns.

He then starts talking about stock investing to friends, family, practically everyone — bragging about a stock that has given him 20% in just a few weeks’ time and another that has earned him 100% in just a year’s time.

This sense of optimism becomes contagious and more people are enticed to join the stock market because “I don’t want to be left behind.” Those who do not even understand what stocks are and how the stock market works become instant investors and the next day start talking like stock market experts giving their own stocks analysis and trading advice.

‘Market Peak’ phase: Euphoria

Then comes the “Market Peak” stage. During this phase, stock prices reach unprecedented levels and stock markets achieve all-time highs.

Everyone’s enjoying the party and euphoria dominates the market. New and old stock investors alike are making a lot of money, and regardless of the stock they buy, it seems they have struck gold. Yes, including those stocks generally considered junk or speculative.

Investors are lulled by their unfailing stock pick prowess, and even those who just joined the market weeks or months ago buy stocks here and there as if they’re just buying new shoes or clothes. Hyped by stock market analysts proclaiming that new highs are coming, investors keep on buying stocks because “Everything’s going up and will still be up in the future.”

‘Market Decline’ phase: Fear

And then, prices start falling. A brand new set of analysts would emerge saying stock prices are inflated and that the stock market is overvalued.

Rationality starts to return in the markets, and those who realize they have paid a lot for a stock that is junk starts dumping these stocks. Investors who merely take cues from large institutional brokers follow suit, selling stocks here and there.

Retail investors, still reeling from the euphoric party in the previous stage, do not seem to understand what’s going on. Most of them cannot believe the party may be over. And yet they follow the herd and start unloading their portfolio too — sometimes even at a loss.

You’ll then notice that during this stage, the conversations about stock markets have started to decline. Gone are the day-to-day updates and stocks analysis of so-called stock gurus. News programs have moved back to reporting politics and entertainment. And your friend who has previously bragged about his huge earnings in this and that stock has suddenly gone quiet.

But the dark days are not yet over.

‘Market Bottom’ phase: Panic

The market continues its slide and reaches a bottom not seen by investors who recently joined the market. Prices have dropped to very low levels, creating panic especially among newbie investors who are now stuck with double-digit losses in stocks they just bought weeks ago.

Blogs, forums, and Facebook discussion groups, among others, are now dominated by posts of members asking “What do I do now?” And yet, most of the “experts” and “gurus” who paraded themselves during the Market Surge phase have disappeared or have gone quiet.

Newbie investors decide to take cues from movements in the stock market and seeing that “Sell! Sell! Sell!” seems to be the dominant mantra, are left to make a convenient — albeit painful — decision: that is, to sell at a huge loss.

This gloomy atmosphere drags on for years, and several investors realize stock market investing is not for them. They return to their normal lives, with a decision to permanently shun away from stock trading.

And we thought it’s over. But then, years later, the market picks up again, prices start rising and investors realize: the “Market Surge” phase is back.

The cycle has gone full circle and a new set of investors will join the cycle. In this next round, we just hope, stock investors would know how to be on top of the Cycle of Emotions in Trading.

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  • Very impressive article. I have read each and every point and found it very interesting

  • Pitot

    Hi James.
    I say this piece is great! Thank you so much.
    Hope that the “experts” and “gurus” can read and reflect on this.

    • Thanks @pitot:disqus! It is also my hope that those who present themselves as “gurus” and “experts” be more responsible when making any claim. Stock investing is not easy and is definitely not for everyone so they must guide and handhold those they lead, especially the newbie stock investors.

  • Kanon

    Very nice article, when I started reading about stock market all signs says that we´re in Euphoria stage, at may naging kaibigan din ako na nang invite nang nanginvite nadin ng mga kakilala at kamag anak para sumali sa stock market, mula nung bumaba ang PSE di na kami nakakapag usap masyado

    so…. does this mean we´re now in Market decline phase: fear yeah?

    • Hi @Die_Hexa:disqus, no one can really accurately say if we’re in the Market Decline phase right now. It still depends on the stock investor to make that assessment. Some analysts say we’re already in Market Decline after peaking in May, while some say stocks have bottomed already. I suggest we all take these comments with a grain of salt and we decide our investing strategy based on our own analysis and evaluation.

  • Sofia Market

    This article is correct when it says it is a cycle that is exactly why
    Experts and Gurus are always preaching to “INVEST LONG TERM” on
    reputable companies with very good fundamentals, AND make sure you have
    EMERGENCY FUNDS because such cycle do exist (you don’t want to be selling at a time of emergency when the cycle is at its decline stage). TIME is your best friend in
    stock investing. Think 20-30 years from now what happens to your money
    when you’ve amassed plenty of shares investing in companies with very
    good fundamentals (i.e. with projected high growth over the years). Come time
    you want to cash out some of your chunk shares just make sure its on a
    “Euphoric Phase”. Like what’s mentioned in this article it is a Cycle
    therefore stage of Euphoria will always come. That’s your queue when you
    sell (you don’t have to be an expert to figure that out). There are
    risk yes, but which investment hasn’t. If there is one that claims to be
    risk free then that is nothing but a SCAM. The problem with our country
    is we lack the proper education about stock investing and we are in
    general so ignorant about this investment option, yet a lot of us would
    jump into the false ideology of get easy rich schemes like pyramid
    marketing, in a heartbeat. Stock investing has been proven over the
    years as a legit way to invest money and grow, by highly industrialized
    countries. All we need is to take time in understanding its basics and PATIENCE.

    • I agree, @sofiamarket:disqus. You raised very good points in your comment. Thanks for dropping by!

    • florsan

      i extremely agree on that…lack of knowledge further

  • mae

    ur right..but im curious if theres anyone expert on this?

    • Hi @disqus_8MJNIQ2nVw:disqus, no one is an expert in the stock market. Be wary when someone make that claim. Even Warren Buffett, arguably the best individual who has made a lot of money in the stock market, makes several trading mistakes once in a while, and he has never claimed he knows the stock market so well. So don’t trust people who say they are “experts” in stock investing.

    • Letsked

      Hi @pinoymoneytalk:disqus, sa opinion ko po. Anyone can be an expert on day trading or investing. But no one can win all the time and never lose in the market. So in @disqus_8MJNIQ2nVw:disqus case, tingin ko po may mga experts din. And Mr. Warren Buffet for me is an expert, he’s an expert on investing long term. Through practice, long hours of work, research, failures, challenges and more. He became an expert on what he understand the most and the result was being one of the richest person. Galing no?

      But your right regarding with people who proclaims their an expert, some of them are just promoters or money burning machine. So be aware of them.

  • flamingids

    i agree. there is no 100% in this market. what you can do is research technical and fundamental analysis to reduce the risk of losing… I have yet to study and hopefully find success in stocks

  • Invest on education first. Read more articles like this before jumping on.

  • florsan

    thank you so much guys for the inspirational ideas you’ve shared!i hope marami pa akong matutunan coz i am so interested and i do believe investing in one of techniques to get grow your pinaghirapang pera!….