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The Psychology of the Stock Market |
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By Brigitte Hilgner
Given the
recent turmoil on stock markets all over the globe, David Cohen's
book "Bears & Bulls. The Psychology of the Stock
Market" which was published a couple of years ago seems even
more topical today than it was then. I actually translated the
book into German, but fear not: this is no cheap advertising, I
really believe that the book can be helpful.
Cohen is a
psychologist, approached the stock market as an interested layperson
and has compiled his findings (a considerable part of the book is
based on interviews with stock brokers and bankers, mainly in the UK)
into 300 easy to read pages. Even if you are no financial
wizard, you won't have difficulties understanding him, and there is a
glossary at the end of the book.
Cohen starts
with a brief overview of some spectacular historic bubbles
("unwise and greedy financial speculation" - like some in
New Market stocks) to demonstrate that they are nothing new.
Would you ruin
yourself for a tulip bulb? No? Well, quite few Dutch
people did in 1635/36, when the price of a bulb would have bought you
a nice house, and bulb prices were quoted on some stock
exchanges. (And then there is this story of a sailor who
mistook a bulb for an onion and ate it with a pickled herring.
The owner of the bulb was not amused.)
Of course, we
don't invest in tulip bulbs anymore, but we might well invest in
bonds and stocks, in funds and derivates. Remember Nick Leeson
who single-handedly ruined Barings Bank in 1994? How did he do
it? He traded in Nikkei 225 contracts. You want to know
what that means in plain English? He was betting. He
placed bets that the Nikkei 225, the main Tokyo Stock Exchange index
(the Dow Jones of Japan, so to speak), would reach a certain score at
a certain day. Perfectly legal. Stock brokers do it all
the time. Nick placed other people's money on the wrong score,
lost heavily, managed to hide his losses, placed further bets to
recover his losses, lost again - and when he was found out, it was
too late: about GBP 800 million down the drain. Why didn't his
bosses find out earlier? They did not quite understand what he
was doing. Oops. Sorry. Bye, bye Barings.
By the way:
Nick Leeson is just the tip of the iceberg and by no means the only
broker who gambled his clients' money away. So, if you don't
want to say bye bye to your hard-earned money and have nightmares
over your investments, you should listen to some simple advice.
First of all,
you should find out what type of investor you are - risk adverse or a
risk-taker (a questionnaire in the book will help you to do
this). The rule of thumb is: the higher the interest to be
earned, the higher the risk. If you want to make a quick
killing, you probably have to take high risks and be prepared to lose
as quickly and heavily. So make sure you understand what you
are investing in. In general, bonds offer comparatively low
interest rates but are safe (no thrill watching their price curve!),
funds are generally "safer" than stocks (because they try
to spread the risk - but funds, too, can lose in value), but beware
of hedge funds, which are highly speculative. Derivatives
("financial products whose value is derived from something
else" - such as Nikkei 225 contracts) are something for
gamblers. Yes, I am generalising, but you get the idea.
Stock brokers
love clients who just hand over the money and let the broker decide
what to do with it. Even if your broker is absolutely
trustworthy, this might not be in your best interest, for several
reasons. Most brokers specialise in certain industries.
If your broker is an expert in IT but you want to invest in IT and
textile, he might not get you the best deal in textile stocks,
because he does not know this market. Moreover, not all brokers
are as independent as they should be. Consider the following
common situation: You have an account with Bank A and tell the bank
to buy shares in company Z on your behalf. The Bank itself
holds large stakes in company Z, one bank manager sits on the board
of this company. Company Z is not doing well, but to avoid
making things worse, Bank A does not want anyone to know. So
the bank's brokers are advised to hold on to the stocks of company Z
and recommend them, even if this is not in the interest of the
brokers' clients. Guess who's going to lose if something goes
seriously wrong with company Z?
If you follow
the US-American news, you probably read about some banks being fined
heavily, because they acted to the detriment of their clients in the
way I just described.
Even if
brokers can act independently, they might still - unconsciously - be
biased in favour of or against certain stocks. Cohen discovered
that brokers (and investors) get emotionally involved: such an
attractive company, really nice people at the helm, has been around
for ages, I remember their products from my childhood - and then they
hold on to stocks far too long and lose money. On the other
hand, it seems to be much easier to ditch shares of companies whose
business one does not quite understand at the first sign of trouble
(maybe one of the reasons why the New Markets have been taking such a
hammering for the last year and a half).
Cohen does not
give any direct advice, but it becomes clear that he sympathises with
those investment advisors who recommend that the investors themselves
gather information about the companies they want to invest in and sit
down with balance sheets and pocket calculator to work out which
business is sound and what to avoid. They should also give
their brokers instructions or at least agree some guidelines (e.g.
50% long-term safe investment, 25% short-term, and another 25% to
'gamble' with). The story of some well-known investment gurus (Warren Buffett, George Soros, etc.) provides some insight into the possibilities of getting rich by playing the stock market. But before you now think that you can easily follow in their footsteps by copying their action, consider this warning: studying the art of Leonardo da Vinci for years won't necessarily make you a second Leonardo ... |
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About the Author... |
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