Why People Lose Money in Stocks: The Emotional Cycle of Investing

Pinoy Money Talk

Here’s one interesting thing about stock market investing which I learned from my finance professors back in college:

The number of conversations about stock trading is directly proportional to the rise in prices in the stock market.

What does that mean? You’ll notice that as stocks go through a bullish phase with rising stock prices, more and more people start talking about stocks and stock investing.

You’ll notice this in social media, especially on Facebook and Twitter, where just about anyone would have an opinion about stocks to buy and sell. You’ll also see a lot of people posting their stock portfolio and their purported stock market gains, thus confirming that:

The number of conversations about stock trading is directly proportional to the rise in prices in the stock market.

This is always evident in the Philippine Stock Exchange (PSE) during periods of bullish stock market performance.

During bullish periods, everyone becomes a stock market expert

Don’t you notice in the PSE during times of rising stock prices, the average person becomes a “stock market expert” talking about how he is “winning” in the stock market and how much money he has already made?

Several people — whose background, experience, and expertise we don’t know — emerge and promote themselves as “stock gurus” offering trading advice here and there.

You’ll know we are in this optimistic stage when news programs that usually focus on politics and entertainment only (sometimes, both politics and entertainment simultaneously in the same news report!) start to insert segments about stock markets and how the average person can make money from stock investing.

Vicious cycle of stock market investing

Similarly, you’ll know that the market is entering a decline or bearish phase when posts and conversations about stocks begin to dwindle. You might have noticed that your Facebook group, typically crowded previously with posts on stocks, seems to have gone silent or have reduced the number of people participating in stock market discussions.

This is no surprise, because this simply confirms the vicious cycle of stock market investing. Stock prices rise and fall and stock markets cannot go on increasing year after year after year.

As seen in this infographic summarizing the 1-year performance of the Philippine Stock Exchange index (PSEi), there will be periods when the stock market is at towering highs but there will also be times when the stock market is at an abysmal low.

1-Year Return of PSEi from 2010 to 2019

PSEi Annual Returns

Closing Prices of PSEi from 2001 to 2019

YearYear-end Closing PricePSEi 1-Year Return
20187,466.02 -12.76%
20178,558.42 25.11%
20166,840.64 -1.60%
20156,952.08 -3.85%
20147,230.57 22.76%
20135,889.83 1.33%
20125,812.73 32.86%
20114,374.96 4.14%
20104,201.14 37.62%
20093,052.68 63.00%
20081,872.85 -48.29%
20073,621.60 21.43%
20031,442.37 41.63%
CAGR (Annual Return)9.46%

In the last 10 years, from 2010 to 2019, the PSE closed the year up (versus its level from the start of the year) seven (7) times out of ten. In 2010, the PSE had its best 1-year return of 37.62% which means if you invested P100,000 in the PSEi at the start of the year, you ended the year with total money worth P137,620!

But in 2018, you would have lost 12.76%, so if you invested P100,000 at the start of the year, this would have been just P87,240 at the end of 2018.

This vicious cycle of stock market investing is captured in the Cycle of Emotions in Investing, which explains why people lose money in stocks.

Emotional Cycle of Stock Market Investing

Let’s take a look at what usually happens when stock markets undergo their Peak-Decline-Bottom-Surge cycle, which coincides with the stock market investor’s Emotional Cycle of Investing.

The Optimism Phase in Stock Investing: Market Surge

The “Market Surge” phase is surely a stock market phase we’re all very familiar with.

During this phase, almost everyone is optimistic because all stock picks have been good picks, generating consistent returns month after month after month. It seems that 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 and intelligent stock investor. Indeed, almost all his stock picks have made him money. To his surprise, even stocks and companies he has not heard of have been giving him enticing returns.

He then starts to brag about his newly-discovered stock market prowess to friends, family, practically everyone — yapping about one stock that gave him 20% profits in just one week or another stock that has earned him 100% return in just two months.

This sense of optimism becomes contagious and more people become enticed to join the stock market because — FOMO alert! — the Fear of Missing Out (FOMO) or “I don’t want to be left behind” mindset kicks in.

Those who do not understand what stocks are become instant investors and, in just a few days’ time, also start talking like stock market experts giving their own analysis and trading advice.

The Euphoria Phase in Stock Investing: Market Peak

After the “Market Surge” phase comes the “Market Peak” stage.

During this phase, stock prices reach unprecedented levels and stock markets seem to break records and achieve all-time highs.

Everyone’s enjoying the party and euphoria dominates the market.

New and old investors are making lots 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 newfound “stock pick talent”, and even those who just started trading weeks or months prior buy stocks as if they’re merely buying new clothes.

Hyped by stock market analysts proclaiming that new highs are coming and that “Stocks will still go up in the future”, new investors come in and old investors keep on buying.

The Fear Phase in Stock Investing: Market Decline

But then, in an instant, stock prices start falling.

It starts with minimal negative daily performance of the PSEi — that seems to happen more frequently than before — which grows to 1% decline in a day to 2% or 3% huge daily decline.

A brand new set of analysts then emerge proclaiming that stock prices are inflated and that the stock market is now overvalued.

Rationality starts to return, and those who realize they have paid a lot for a stock that is junk starts dumping these stocks. Newbie investors who merely take cues from so-called stock market gurus and hypers then follow suit, selling stocks here and there.

Cycle of Emotions in Stock Market Investing

Some unfortunate 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 just decide to follow the herd and start to unload their portfolio, sometimes even at a loss.

You’ll then notice that at this stage, the conversations about stock markets in mainstream and social media 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 previously bragged about his huge earnings in this and that stock has suddenly gone quiet.

But the dark days are not yet over.

The Panic Phase in Stock Investing: Market Bottom

The market continues its slide and stock prices drop to very low levels not seen by newbie investors who just joined the market.

This creates panic among traders and investors who are now dealing with huge losses from stocks they just bought weeks or months ago.

Blogs, Facebook groups, and YouTube channels that deal with stocks are now dominated by posts and comments of people asking “What do I do now? Should I sell this stock at a loss?”

You’ll notice that most “experts” and “gurus” who paraded themselves during the Market Surge phase have now disappeared.

“Sell! Sell! Sell!” seems to be the dominant mantra and several investors are left with no choice but to make a convenient, albeit painful, decision to sell their stock holdings at a huge loss.

This gloomy atmosphere drags on for months, sometimes years, with a handful of investors realizing that stock market investing is not for them. They return to their normal lives, with a decision to permanently shun away from trading.

And we thought it’s over.

But then years later, the market picks up again, stock prices start rising, new experts and gurus begin to emerge, and experienced investors now 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 hope, that stock investors would now recognize to manage and control the Cycle of Emotions in Stock Market Trading. Otherwise, the cycle will simply repeat, claming a brand-new set of victims.

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Pinoy Money Talk is an educational website about money, banking, investments, and personal finance which started in 2005. Its group of five writers consists of one equity research analyst, one fintech startup owner, one finance educator, and two investment professionals.