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The investor's behavior 

The two laws of the finance • The typical errors of the investors

It is worth to be satisfied and to take home what it has already been earned instead of leaving the positions open and to not only risk of losing the potential profit, but also the initial capital? Moreover, besides applying the fundamental analysis or the technical one as to decide what actions are to be chosen and when to enter or to go out from the market, is there any "law" of the financial world that can be of help? As always much can be learned from the errors done in the past.

The two laws of the finance

Never hold a position against the market

What does this mean? It means that play in an opposite trend to the course of the market - sell when the market rise and, vice versa, buy when it goes down - is very dangerous. There are investors that, waiting for a collapse of the market, sold the stocks in their portfolio and, sometimes, also those that don’t own, in the hope of clearly repurchasing not too far in the future for a lower price. And then one loses whole fortunes. Furthermore, who has burnt big patrimonies, buying stocks when the market went down, in the wrong conviction to anticipate the moment of the turn, when the quotations would have taken back the run to the rise. In order to draw from the reality of these two opposite situations it doesn't need to go too far in the past: all it takes is observing the course of the American and Japanese stock markets for the whole decade of the nineties.

The American Exchange, despite various warnings from financial guru and the same ex-president of the Federal Reserve, Alan Greenspan, has kept on climbing, also after the quotations had scored amazing performance. Who had invested in the Dow Jones Industrials Index in the beginning of the '90s it would find himself in the beginning of 2000 with a capital around 5 times superior. The Japanese Exchange, has kept vice versa on decreasing, also after the level of the quotations had gone down to less than the half in comparison to the maximum ones reached to beginning of the Nineties. Who had invested then in the Nikkei225 Index would find in the middle of 2000 with a capital equal to the 50% of what invested. Who has betted against these two markets, selling American stocks and/or buying Japanese titles, would have seen huge values disappear.

Be careful of the rises in long periods

If it is true that to go against the market constitutes a risky operation, it is not less hazardous however to purchase after a long period of upward trends, when it is very probable that the quotation has got near to the maximum values, as well as to sell after a long period of downward trends when it is probable that the courses are by then near to the lowest ones. However, such affirmation must not be read in an opposite way to the preceding one, otherwise, the moment for investing in the market would never come. If, in fact, it didn't need to invest in a contrary trend of the market courses, there would be no spaces for the stock investment. But it is not like this: what it is suggested here it is to avoid taking decisions of investment drawn by, more than from the logic, from the anxiety to run after the others. This statement is particularly important because the many investors lately, have been shown as some irrational investors, especially when they have acted by themselves, directly buying stocks, instead that quotas in investment mutual funds. Besides, the irony of the fate has wanted that, when they have acted in that way, they had the unlucky to enter the market right when this was next to the maximum levels, so that they remained so deeply burnt by the experience that to keep themselves distant of a reentry (again, on the maximum levels). Therefore, as it doesn't need to joke with the market, trying to put the own investments against it, so that it doesn't need to have blind trust in its most recent past. The market, in a certain sense, is a ‘traitor’: it punishes right when it seems to offer the greatest trust. 

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The typical errors of the investors 

Beyond the two basic "laws" of the finance there is another series of errors that the investors do. Errors that have been underlined by the so-called behavioral finance, born in the middles of the Eighties: if you recognize yourself in the following descriptions, it is better review at least partially your style of management of your investments.

The excessive trust

Many investors overestimate their ability to foreseen the future, that is to say they do forecasts assigning low margins of error. The excessive trust brings to hold to reckon to have done correctly the choices of the stocks on the base of a personal analysis and to have been unlucky because of external causes in the purchase of losing stocks. Let’s take as example an investor that chooses at random the stocks, who attributes to himself the correct choices made but attributes instead to the adversity those that are wrong. In the time it will tend to increase more and more the trust in his skills. Excessive trust can be at the base of the phenomenon of excessive trading that has deleterious effects on the outcome of the portfolio, as well as to bring to the decision to focus all purchases on a few titles that are perceived as ‘correct’.

The representative episode

Too often the investors think that a certain episode is representative of a certain phenomenon. For example, after having observed the prices of the Stock Exchange climbing for some sessions, they have the tendency to jump to the conclusion that an upward trend of a long period is in action, forgetting that long episodes of increases of the prices can also take place in phases of bear market. The financial consequence is that the investors can have the tendency to excessively focus themselves on those stocks whose prices have been climbed in the past, on the base of the wrong extrapolation that they will keep on growing in the future also.

The refusal to modify the opinions

In general the investors and the individuals have the tendency to remain affectionate to his own convictions, and they are little available to change them during a clear opposite evidence. 

The narrow point of reference

The investors often neglect the general picture to focus themselves on a particular aspect. In the financial field, this for example means to give too much attention to the course of one or few stocks, ignoring that of the general investment. This can involve in turn errors in the financial management. For example, at the beginning of the year the investment can be split into 75% bonds and 25% stocks. If we suppose that the stock market loses 20% and that the bond market earns 10%, the general wealth has grown of 2,5%. Yet, if the investor looks only at the stock compartment, he can end up selling the titles in loss as pure reaction to the disappointment of the losses incurred in the stock prices. 

The aversion to the ambiguity

The investors often fear the situations in which little information exists in comparison to the risks that are required to take. This principle can bring to good choices under the financial point of view, as when one refuses to purchase a stock on which little information is available. In other occasions however, this characteristic can bring to wrong choices, for example when one diversifies to less the portfolio from the international point of view because it is perceived as "to know too less" about the foreign firms.

Know the basics for investing in the stock market

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(source of the article is the book "Shares", Marco Liera, Il Sole 24 Ore)

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