Market analysts are busy day and night trying to predict the future based on charts and graphs centered around national economic data, global economic concerns, and corporate financial performance. Even with all of this brain power, there are big holes left in the theories of market analysts due to the pitfalls of market psychology.
Behavioral finance studies show time and time again the economy is greatly affected by consumers’ thoughts, hunches, and feelings that contradict sound market analyzing all the time.
The Bull and the Bear
Market sentiment is the overall feeling of the market at any given time, which is actually scientifically measured by behavioral finance analysts. The mascots of the bull and the bear are used to describe the climate of the market, and the attitude of individual investors. The bull is optimistic that the market is going to do well, or continue to do well, so he buys every chance he gets. The bear is sure that the market is taking a turn for the worst, and that he should get out while he still can, so he sells. A bullish market describes one where everyone seems to be keen on taking risks, while a bearish market is the opposite.
Individual investors can be pessimistic or optimistic in their own field, and even bearish or bullish about different individual investments. The best investors are those who have both bearish and bullish tendencies, and can balance the two out by successfully predicting market activity. Contrarian investors are those who prefer to invest against what the general market climate is, banking on at least some of the masses being wrong.
The Bandwagon Effect
Consumer behavior is influenced by the bandwagon effect, or herd mentality. In a financial sense, the bandwagon effect occurs when people begin making decisions based on what everyone else is doing, even if it goes against their own judgement or preferences. People will wear a popular brand, even if they get the nagging sensation that what they’re wearing doesn’t really look good on them. Consumers will fight long lines and huge crowds to obtain the latest technological devices that they don’t need, and might not even want. Investors will sink money into stocks that are popular amongst peers, even if there’s no real evidence of impending success.
Along with a general market feeling affecting individual investor’s decisions, reflexivity has an impact on how a person will invest as well. A person’s biases, thoughts, and values will influence whether they buy or sell, sometimes without their even knowing it.
In a business where most people follow their “gut” at least part of the time, it’s easy to see how reflexivity can really make a difference. This variable is nearly impossible to track, yet it impacts the market in a real way every day, since every individual investor is considering their inner feelings when making financial decisions.