Investors Get in Touch with Feelings
Aug 25 10:05pm ET
By Denise Duclaux
NEW YORK (Reuters) - Investors asked few questions when their red-hot love affair with the stock market yielded wads of cash.
But now that the relationship has soured they are desperate for answers -- and that's good news for the pundits, fortune tellers and fund managers who specialize in sizing up the market's tempestuous psychology.
"It's sort of like when you have a good marriage, you don't go to a marriage counselor," said Michal Ann Strahilevitz, a marketing professor at the University of Arizona. "When you have a bad marriage, you go to a marriage counselor."
Frazzled investors are sifting through the market wreckage to discover what led them to funnel money into the fragile technology bubble that popped in 2000, and how they can learn -- and profit -- from their mistakes.
Often as not, they are finding that the answers don't lie in the hard-and-fast rules of textbook finance, but in the more amorphous world of the human psyche.
"Eventually you are dealing with humans behind computer screens or you are dealing with humans on the street," said Arjen Pasma, a portfolio manager at investment bank ABN Amro. "If you want to understand how the market works, you have to also understand how people come to investment decisions."
A robust cottage industry offers to help investors decipher those market dips and blips that seem to defy logic. Books, research, funds and even counselors are helping investors look into their hearts and minds for clues behind the ticker tape.
"If we all behave irrationally in the same way then it does affect the market," said John Nofsinger, author of 'Investment Madness: How Psychology Affects Your Investing...and What to Do About It' (Financial Times Prentice Hall; $24).
"That's what has happened and what has drawn interest not only from academics, but from practitioners who say, 'If this is true then how can I make money off of it."'
WALL STREET TAKES TO THE COUCH
Textbooks teach that investors buy stock for rational factors, like earnings and anticipated growth. But the wild swings of the past two years shows that these fundamentals sometimes don't matter much at all.
"People are realizing there is a lot of irrational behavior," said Woody Dorsey, president of research firm Market Semiotics. "In fact, my premise is markets are always irrational. This is not necessarily pleasant for a lot of people. It introduces a much more uncertain environment."
Dorsey forecasts market movements using behavioral economics, a methodology which he says can make sense of the market's inherent irrationality. He polls about 80 traders by phone and e-mail daily to capture their "gut feeling" on the market and tracks that against Wall Street's sentiment over history.
"The psychological approach is not really something that is fully accepted by mainstream," Dorsey said and many of the investment firms that are his clients prefer to go unnamed -- still a bit shy about mixing finance and emotions. "But it's going to be the next important development in market analysis," he adds.
Some are taking investor psychology to a more intimate level. Adrienne Laris Toghraie works with traders to discover the psychological factors that are sabotaging their investment performance. After an evaluation, Toghraie may instruct her clients to do some reading, attend one of her seminars or participate in one-on-one counseling with her to discover, for example, why they keep holding onto a dog of a stock.
"All that stuff needs to be cleared up in your life," said Toghraie, president of Trading on Target. "Trading is performance and to be a good performer you have to have a psychological stability that keeps you at performance level."
MAKING MONEY OFF FINANCIAL FOLLIES
Investment banks are betting cold-hard cash can be made off investors' whims. ABN AMRO launched its Ratio Invest Fund in April 1999 and has added two more behavioral funds.
The Dutch bank spent about two years researching which stocks will outperform based on investor psychology. The strategy is still a work in progress -- the Ratio Invest Fund has underperformed its benchmark since inception.
The fund managers chose four psychological factors that influence investors' decisions and stock prices. Investors, for instance, tend to be lured by a company's image -- gravitating to large, stable firms like soda giant Coca-Cola Co. .
"People tend to want to be invested in these type of companies, because they offer some type of conformity and safety," Pasma said. "People think you cannot lose money on Coca-Cola, but you can lose money on some small stock you don't know very well."
ABN Amro also takes a look at investors habit of overreacting to headline news and their tendency to ignore some fundamental developments -- like an increase in research and development that may lead to better earnings. Overconfidence, investors' tendency to think they are smarter than their peers, is the final factor behind the strategy.
IT'S BACK TO SCHOOL FOR INVESTORS
The University of Arizona's Strahilevitz and Dan Ariely, a marketing professor at MIT's Sloan School of Management, are researching parallels between the way people react to physical pain and the way they deal with the shock of investment losses.
"Investors are more interested in investor psychology than they were before because a lot of people were saying, 'God, I am such a freaking genius. I am planning to retire at 35,"' said University of Arizona's Strahilevitz said. "Now people are saying 'Oh my God, how could I fall for this? I need help."'
In one experiment, Ariely used a body suit that circulated hot and cold water over volunteers to study their reactions to pain and pleasure. So far, the researchers are finding that type of emotion isn't all that different from the ups and downs of investing.
"We do know there are people who are just walking around like they have been hit on the head with a piano because they lost all their net worth," Strahilevitz said. "And there does also seem to be a healing process."
She has rewarded volunteers who respond to her 15-minute online surveys with free T-shirts or money toward charities. Strahilevitz, who advertises the surveys on message boards, has noticed responses have dwindled as the market heads south.
"We started in a bull market and the one thing that was amazing is how everybody responded to our survey. I would put out one little notice on one little message board and the next day we would have a ton of responses," she said. "Now you go to the same message board and it's like pulling teeth."
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Dalin: Nice to hear from you...glad you got out on the boat. I'll be back out on our Sea Ray over the Labor Day Weekend.
Sorry you had to do some layoffs -- they are a very unfortunate part of our economic cycles...They are also quite unpleasant for all parties involved.
It was nice that the market started to wake up on Friday and move to the UPside. I'm hoping for a close on the Naz of over 2000 by the Labor Day Weekend...=)
Best Regards,
Scott |
