Investor Psychology
To be successful with stocks, you need to understand the psychology of investors. In this post you should gain a basic understanding of what drives an investor to buy and sell. Using the S&P 500 as an example, I’ll explore the psychology behind the S&P’s movement.
On Sept 19, 2014 the S&P hit a new high at 2019.26. After doing so, the S&P dropped 10% to 1820 by October 15, 2014. Since the market couldn’t go higher than 2019, that is called “resistence”. The market faces resistence there.
Now suppose you bought a stock when the markets were at the peak and your stock dropped 10%. What would you be thinking? Seriously put yourself in that positin. Ever been down 10%?
99% of investors no longer care about making a profit. All they want now is to get their money out so they can sell their dog and move on.
New investors see the stock down 10% and start buying because it’s a bargain. So now the buying fuels the S&P to rise. As the market goes up and the losers are getting their money back, they start selling their holdings, happy to break even. As the market rises, the selling starts to increase. On Nov 3 the S&P hit 2024. Those who bought at the peak of 2019 can now get out and break even.
If you look at the period from October 31 to Nov 6 you can see the market was facing resistence and moved sideways for the week. What is happening there is that the S&P is back around 2019, the same spot where investors sold before. Selling picks up and there are now as many sellers as buyers, hence the sideways action.
Soon all the losers have gotten their money back and the only people investors left are the buyers. Once the sellers are out, the market should soar and that’s what are you are seeing from Nov 6, 2014 to today, Nov 11. There are no more sellers at this time. The market should continue to rise.
Now as the market continues moving higher. Those who bought in at 1820 are realizing they have made 10%+ in a month and will soon start selling and locking in their profits (our friend greed and fear enter their mind).
As the selling increases, the number of sellers is equal to buyers and we get the sideways action we are now seeing in the S&P 500.
Since 1820 there have been a lot of buyers on the way up and once their money is fully invested, the market slows down. when the market slows, those with big profits (got in near the bottom) realize the gains are over and start selling and locking in profits. When other winners who are holding start to see the market beginning to drop, they get scared and sell too to lock in profits and hence, the market moves back down.
Now not all people are smart and get out before the correction. Those who got in at the top start thinking, “No, I can’t sell now I lost too much.” so they hold. As the market rises, they soon sell because they got money back and the viscious cycle repeats.
