Investors in the stock market must consider many factors before making a buy or sell decision - at least, they should.
The stock's fundamentals, the company's future prospects relative to its market position, the economy and many other factors come into play when making buy or sell decisions.
Most stock investors may want to think their investment decisions are based on pure logic and reason, we all know that's not always the case.
A variety of factors beyond fundamental or technical analysis shade our decisions.
There are three main non-market factors that often drive decisions to buy or sell:
- Fear - The fear of loss is the single most powerful non-market, non-analytical factor in sell decisions.
- Greed - Many investors are emotionally stampeded into making poor buying decisions by media noise about a particular investment or hearing colleague brag about their latest great investment.
- Time relevance - We all struggle with the belief that happens today is more important than what happened yesterday or last year. This is where the "it's different this time" fallacy originates.
Fear panics investors into selling at just the wrong time. If the company is still a solid, fundamentally sound investment, you are better off riding out a downturn in the market rather than trying to time when to sell and when to buy back into the stock.
Yet, fear of loss is a powerful emotion and many investors panic when they suffer a loss and sell only to buy the stock back at a later date for a higher price than they sold at.
Greed urges us to buy at just the wrong time. The media is breathless over its latest darling and all your friends are bragging about how much money they are going to make and you can't resist the opportunity to make some easy money.
The stock market is notorious in punishing investors looking for easy profits. This is the behavior that inflates balloons and the market is only too willing to pop them when you least expect it.
These emotions often drive the buy high - sell low strategy that dooms investors who buy or sell based on their "feel" for the market or just because they don't know any better.
Professional investors are not immune from these lapses in logic and may also be caught up in the moment (whether it is panic selling or frenzied buying).
However, there are other factors stock investors should consider.
One of the most influential non-analytical forces convinces investors that whichever direction the market is moving at the moment is the direction it will continue to move.
If the market takes a swing up for several days, some investors will assume it will continue in that direction despite historical and analytical evidence to the contrary.
For example, after the market has marked a significant upswing, it is probable that smart investors will take profits.
Their selling will often halt and reverse the advance. Less sophisticated investors who may have joined the party late, bought near the point where the trend reversed are left watching the falling price reduce their investment to a loss.
This is not to say the market won't resume its upward swing after a pullback, but there is no rule that says this must happen.
The reverse is true when the market slides significantly. Some investors will assume that is the market will continue moving down.
However, it is often the case that prices will drop to a point where stocks become a bargain and investors step in to grab some values.
Their buying will usually reverse the trend, at least temporarily.
What is happening is a factor called time relevance, which says recent events are more important than historical ones.
There is some truth to the idea of recent events having more relevance that past actions, however don't let your short-term memory override your logic.
The point for investors is don't use the direction of the market as a sign it will continue moving in that direction indefinitely.
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