By Russell Robertson, CFP
What makes markets go up and down? Nobody really knows. It’s largely a psychological phenomenon that just happens, but that doesn’t sound particularly
convincing if you’re on TV, so they come up with things like “it’s the robo algorithms” or “investors are worried about the increasing costs of doing
business” - both of which are literal quotes I heard last month after the market’s worst-ever (at the time of writing) one-day point loss. Both explanations
sound decently plausible, except that they’re not.
Stocks are worth what people are willing to pay for them. There are all sorts of valuation metrics and equations out there to try and tell you if stocks are
“cheap” or “expensive,” but there’s no single intrinsic value of what a stock should be worth. If people want to buy a stock more strongly than other people
want to sell it, it goes up. It’s not about the number of buyers vs. seller (though you hear that too - “there were more buyers than sellers” - false. There
are always the exact same number of buyers and sellers, otherwise the transaction doesn’t happen), it’s about who is more desperate.
Over the last few years, lots of “momentum” investing strategies have popped up. The idea behind these is simple: if the market is going up you buy, and
if it is going down you sell. It’s a strategy that has worked fantastically - and, importantly, one that hasn’t been triggered to sell since at least the middle
of 2016. That’s a lot of buying pressure.
However, everybody knows that stocks don’t go up forever in a straight line, even if they do for over a year. Everybody knows that volatility hasn’t
disappeared forever, even if it sits at historic lows for a year. Everybody knows that a correction is coming and wants to get out of the market before that
happens.
Because they’re expecting it, any little (dare we say, normal? Or even, healthy?) selloff gets seen as the start of that correction. Each further decline of
the market convinces more people that it is actually the crash they’ve been fearing, and so they sell too. Then those momentum strategies get involved,
because all of a sudden you have negative momentum in the market, and so they are triggered to sell. Selling begets more selling.
All at once everybody is desperate to sell, and nobody particularly feels great about buying. So the market drops. Fast. That’s how a 500-pt selloff
becomes a 1500-pt selloff in the span of 5 minutes. Herding behavior and fear. Pure psychology.
It doesn’t take much. Let’s look at Bea Tchikomer, a theoretical resident of Chatham County. Let’s say Bea has 100 shares of Apple stock, and she’s been
sitting on this for a while now ... say she bought it along with her first iPod back in the day. Now the iPod has gone the way of the Walk-Man and Bea
decides she needs to use that $16,000. If she sells her 100 shares at $159 instead of $160, she just erased almost $1 billion from the global financial
system. Billion with a “b”.
So what is one to do in the face of overwhelming psychology? Have a plan, and stick to it. It doesn’t need to be the best plan, it doesn’t even need to be
one that I would agree with. If your plan is buy-and-hold, great, do it. If your plan is to dollar-cost-average, great, do it. If your plan is to have someone do
it for you, great, do it. Just don’t panic sell because everyone else is panic selling. That’s what leads to charts like this. Don’t be a statistic.
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