Behavioral Finance

Zigzags and Wild Polygons

By, 06/12/2008

Story Highlights:

  • Recently, stocks have experienced some downward volatility.
  • Investors tend to feel loss more acutely than gain. This often hurts more than it helps.
  • Markets aren't unidirectional month to month or even year to year.
  • What matters more are your expectations for forward-looking market conditions, crafting a long-term strategy, and sticking to it.

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It's been a tough last few days, no doubt. All the fluxing has some folks grasping for dour news to rationalize the downward volatility. Many are again questioning just how "safe" the stock market is long term. Times like these call for steely nerves. Failing that, perhaps some yogic breathing and maybe a little energy work.

More importantly, remember the root of many flawed decisions: For every objective ounce of pain and loss, men and women subjectively feel it more than double. That's an evolutionary trait born millennia ago when ignoring pain and loss meant certain death—weighting loss more heavily than gain helped us survive and eventually prosper.

But today, humankind's evolutionary paranoia often hurts more than it helps. This is particularly true when progress takes any path but linear growth. Our brains want to reduce everything to simple equations, but the world isn't painted in straight lines and tidy shapes—it's a mess of zigzags and wild polygons.

It follows then that markets aren't the dogged mountain climbers we wish they were, carefully placing one foot after the other. Rather, they frequently move two steps forward and one back. Unfortunately, our brains don't see that as progress. We perceive two steps forward and one back as treading water or worse. And on the shortest time frames it's worse. Those of us glued to flashing red stock tickers experience double the rocky ride down on a given day, yet don't equally enjoy any ride back up.

The point of all this? To avoid evolutionary tricks of the mind, don't focus on short-term volatility. Try to get the better of your stone age brain. Markets aren't unidirectional day to day, month to month or even year to year—they move up, down, slantways, to port, to starboard—you name it.

What matters more is making rational, forward-looking, longer-term bets—then sticking to them through thick and thin or until fundamentals change. No matter how painful today, yesterday or last week was, it doesn't matter one whit to what happens going forward. But how can you reasonably forecast long-term market moves? Ultimately, markets move on the difference between expectations and reality. Today, sentiment remains severely dour. Many think the stock market and the economy are in real trouble, if not outright going to hell in a hand basket. Investors should focus on whether this view accurately reflects reality. Note: Popular sentiment rarely reflects reality perfectly. If most folks overappreciate relatively weak fundamentals, expect scary surprises to bring stocks down. But if most folks underappreciate relatively stronger fundamentals (as we believe is the case today), surprises to the upside will keep stocks buoyant longer term.

Simply put: Stay strong. Find the North Star, get your sea legs, and navigate the swells—asking the stock market to slow its roll is as futile as telling the ocean to calm itself.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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