(Part II - The Asymmetry of Losses, Pains & Fears)
Do you remember the last time you got a slap? On the other hand, when was the last time you got a nice warm hug? Most folks are likely to remember the slap well, who gave it, when it happened and how bad it was. But the hug, hmm, really, when was the last hug you got – don’t remember?
It’s a well known fact in psychology that events that cause unpleasantness or distress have a far deeper impact on one’s psyche than positive events. I am sure you will agree with this from your own personal experience.
How do you feel when (in the markets):
1. You make a profit of Rs. 1,000 and then lose it?
2. You lose Rs. 1,000 and then recover it?
Are both situations equal?
Like most things in life, there is more than one answer to that question.
In the markets (and mathematically), a profit followed by an equal loss AND a loss followed by an equal profit BOTH result in a “no loss no profit” situation. Agreed? But do both these situations result in a similar emotion? What has been your own experience?
For most folks, the intensity of the pain when one loses after winning is far more than the intensity of the happiness that occurs when one win’s after losing – even though BOTH situations may leave you without a profit or a loss! Behavioural Finance (a field that studies the psychological aspects of money and how humans individually and collectively react to various financial conditions) has show that a loss is three times more emotionally intense than a similar profit – and that is why Losses & Pains are asymmetrically more intense than equal Profits & Pleasures.
In other words, if one has to recover emotionally after a financial loss, then one has to make a profit that is 3x the loss that one has incurred; i.e: if you lost Rs. 1000, then the negative emotions would be neutralised only after making a Rs. 3000 profit. Mathematically, that would leave you with a Rs. 2000 net profit and well, you should be twice as happy, but no, you are now just back to the same emotional state as you were before you had the initial Rs. 1000 loss!
Well that’s the general thumb rule anyhow and it points to a very important aspect of how we market participants react after we suffer a loss. The bigger the loss, the greater the profit needs to be. After the big fall (and slap) in the markets since Jan 08, it is no surprise that the volume of trading has come down by half in the Indian stock exchanges. This is simply because many people have just fled the market out of deep emotional hurt.
But here is the more important lesson …
Those who suffered a significant loss are also likely to have suffered huge emotional pain, which perhaps is very traumatic for them. Many others will get into the markets only AFTER it has risen significantly because by then, their fear would have been assuaged with time; and as they watch the markets rise, greed will become a more powerful emotion than the fear.
When the markets start to bottom out and rise again (which they will for sure), many from the above groups will NOT get into the markets due to the FEAR of loosing (even more). That is how we untrained humans react; we will avoid at all costs the situations that caused the initial Losses & Emotional Pain.
The sad part however is that members of the above groups would loose the opportunity to enter the markets when the markets are Low (and then make a significant profit when they rise thereafter). It is because of this that the simple logic of buying low and selling high is not so simple to follow after all!
Because of the asymmetrically higher emotional intensity of a loss, it takes a long time for people to “forgive & forget” the emotional pain. It is only after these folks have gotten over this emotional pain and their confidence has returned will they return to the markets.
Lo and behold! By then the astute, smart and experienced investors and traders would have already picked up stocks at a bargain the market would be up. Alas, this cycle will repeat again and those who don’t learn from this are doomed to further losses. But those who can gain mastery over their emotions and think logically and calmly with a proper investing – trading plan in place will benefit handsomely in the months and years to come.
Which brings us back to the question: How long will the pain last? A tough question to answer indeed but there is a corollary that is easier to answer.
Generally, it takes 3-5 times the amount of time it took for the fall of the markets for the markets to go back up to the earlier highs they were at. Assuming the fall is over (which may not be the case), we have had pain for 6 months and therefore the recovery to 23,000 on the Sensex could take 18 to 30 months! So long? Yep, so long!
However, the far more important question is: Will you be part of the recovery or will you be waiting on the sidelines, outside the market?
I know it is a very tough call. I only hope that this discussion on the emotional processes of a market crash will help at least some of the readers stay cool, calm and collected so that they are well-positioned to take advantage of the significant opportunities that the market is and will offer us in the weeks and months ahead. I will, of course, be sharing my thoughts on these opportunities with you.
In the next and last part of this series on “How long the pain will last?” I shall look at previous crashes in the Indian and global markets to see if they can give us clues on what to expect this time.
Till then cheer up and hope you give and get lots of hugs J
In the meantime, I look forward to your questions, suggestions and well, anything else you have on your mind. Send them to askmusa@gmail.com
( Dr. Musa R Kaiser is a Bangalore-based doctor, equity investor, derivatives trader, investment advisor and most importantly, a financial educator who is passionate about supporting individuals and families achieve their dreams. He is the founder of http://www.bangaloreinvestorsclub.com/)