Friday, April 24, 2009

Analysis of Bear Markets

This is reproduced from my personal website. For full details, click here:Analysis of Bear Markets

There was an interesting article in Wall Street Journal on 24th of March,2001 or so. It attempted to analyse a bear market from sentimental point of view. I agree with them and thought you all might like it too. So keeping the original idea, I am adding most of the thoughts of my own. So please read on:

There are usually three phases, with more or less intensity, in any bear market: Denial, Reality and Surrender.

Denial: When a bear market starts, people deny it. They really don't believe (or at least don't want to believe) that market has turned down. They relate it to previous minor reactions that market had over past couple of years and how market bounced from there every time to make new highs later on. So they are sure that there is no bear market in sight. They keep on buying more and more. They even make fun of anyone who mentions a possibility of a long bear market.
This is the time during which they spend disproportionately more time with CNBC, stock-market related publications like Investor's Business Daily, or on Internet sites doing investment 'research'.
Psychologically
, this phase is of somewhat arrogance, overconfidence and adventure. They still think of profit, maybe much more profit than they initially hoped for because of the opportunity to buy at lower prices. In light sense, they are still under the world's smartest man syndrome, with just little doubt building up on the horizon. (Ask yourself: Were you in that kind of mind-frame most of year 2000?)

Reality: However, the long sustained downtrend in stock prices and bear market confirmations by analysts and media (and the value of their own portfolio) forces them for a very hard acceptance of reality. Now they accept the painful reality. But the pain is not that severe; they still have hope for making up the losses (profit is now so distant they have to abandon even a thought of it). Losses are accumulating so fast, so the thought of break-even is more dominant than an idea about any profit. The pain keeps on getting severe. CNBC and Nightly Business Report on TV start getting on the sideline, time being spent researching on yahoo or reading publications like Investor's Business Daily is cut down.
So psychologically, this is a stage of piling up frustration, tension, stress but deep buried inside, there is still some hope. Now most of the investors kind of decide that they would quit the market once they break-even. They accept the ‘reality’ that markets are crazy and they are not for them. (Ask yourself: are you in that mind frame currently when NASDAQ is hovering around 1800s?)

Surrender: Now a days, you rarely watch CNBC or go to Yahoo! Finance or read Investor's Business Daily for research. The growing pain of reality starts becoming unbearable. The prices are dropping very rapidly and have reduced your portfolio value to levels you never imagined. You have little liquidity left. If you are not balanced by nature and if ambitions and confidence have been your biggest assets so far, you are in more danger. Your very base is shaken. You are angry with yourself; but you want to blame someone else (Rajanish once said, ”It is human to err; but it is even more human to pass on the blame of your errors on someone else”.). Not only money, but also your relationship with your near and dear ones is at risk. Your spouse and your children hopelessly see a different you- irritated, getting mad for no obvious reason, ‘leave me alone’ type of person.
There is no hope for any recovery; you abandon all thoughts of stock prices going up in near to long future (if not, ever). Market downtrend seems as much a sure thing as the up-trend sounded when the bull market was at its peak. Then the ‘prudence’ strikes us: save whatever you can when the whole ship is sinking. So guess what? We sell all those stocks we have been holding on during all that painful period. We feel relived and we are out of the game (with a serious mind not to reenter again in life time). This is called the distress selling and usually a bottom of the bear market.

(Even though how determined you are to quit the game, sooner or later, the rising stock prices of the next bull market would let those emotions take hold of yourself once more and the addiction of the stock market (which had been such a integral part of your life and even your personality during those years of last bull market and very painful bear market thereafter) will bring you back in the game. This is true for 95% people. If so, then why not play it like a game, raising ourselves above those misleading emotions? Only request: keep learning. Keep a diary of your thoughts periodically and watch yourself at each step. )

Take my words: This is the story of not only yourself; it is mine, your friends’ and even those 95% of people who work on wall street, including analysts.

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