Experts are constantly banging on about focusing on company fundamentals.
It's wise advice, but it naïvely assumes a share market that is completely efficient. That is, everyone behaves rationally according to all the public information available.
Investors know from their experience just in 2022 how false this is.
Emotions have a huge impact on how and where ASX shares go. It might be painful for some to admit, but it's true — because everyone participating is human.
To understand what goes on with stocks outside of company fundamentals, AMP Ltd (ASX: AMP) chief economist Dr Shane Oliver this week pointed out how investors can be more emotionally intelligent.
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Recognise everyone else is irrational
The first step is to admit that share prices and investors do not behave rationally.
"Recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of investors," Oliver said on the AMP blog.
"The key here is to be aware of past market booms and busts so that when they arise in the future, you understand them and do not overreact."
By 'overreact', Oliver is referring to behaviour like selling everything during a market bust or piling onto "unstable bubbles".
Recognise you are irrational, like everyone else
By natural extension, the second step is to acknowledge that you, yourself, are impacted by emotions.
"In other words, be aware of how you are influenced by lapses in your own logic and crowd influences," said Oliver.
"For example, you could ask yourself: 'Am I highly affected by recent developments? Am I too confident in my expectations? Can I bear a paper loss?'"
Pick a strategy and stick with it
The next action is to choose an appropriate investment methodology according to your own taste and appetites.
And hold on tight for the long term.
"To guard against emotional responses, choose an investment strategy which can withstand inevitable crises whilst remaining consistent with your financial objectives and risk tolerance," said Oliver.
"Then stick to this even when surging share prices tempt you into a more aggressive approach, or when plunging values suck you into a defensive approach."
If you must fiddle, go contrarian
The last piece of advice is to run in the opposite direction to the herd.
"If you are tempted to trade, do so on a contrarian basis," said Oliver.
"Buy when the crowd is bearish, sell when it is bullish. Extremes of bullishness often signal eventual market tops, and extremes of bearishness often signal bottoms."
Successful investing calls for "going against the crowd" at extreme times, he added, and monitoring investor sentiment research can assist.
"But also recognise contrarian investing is not foolproof," said Oliver.
"Just because the crowd looks irrationally bullish (or bearish) doesn't mean it can't get more so."
