Market sentiment is often discussed as a reason for broad market gains or losses in a given trading day.
While there are many measurable financial factors that feed into sentiment, such as economic growth, there are also softer factors like human emotions, and we can't always count on them being rational!
In an article published on the ASX, two experts discuss how emotion plays into ASX shares investing.
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How emotion drives the market
Karl Siegling, chief investment officer of listed investment company (LIC) Cadence Capital, says human emotions such as hope, fear, and greed can determine whether ASX shares become cheap or expensive.
He says:
The collective emotions of individuals, which is 'the market', play an extremely important role in investing.
The sooner that investors understand how important emotion is, and how likely we are as individuals to make decisions based on emotion, the sooner they will become better investors.
After a lifetime of investing, Siegling says it's "a myth" that stock prices are based purely on value, saying:
Investors are always told to 'buy low and sell high'.
So, we study finance or accounting at university and learn different techniques to value companies.
There's this myth that all we need to do is learn the correct formula to value companies and we can lead a rich, healthy and wealthy life.
ASX shares investors need to understand that industry cycles can take years to play out. This means they could be waiting for a long time to see substantial price gains.
In the movies, everything in the share market happens very quickly. In real life, when you buy a share, you are buying part of a company.
Companies move much slower than people realise. When a business starts improving, that improvement can play out over many years.
It sometimes takes years for a stock to go from being unloved to being loved.
How emotion influences ASX shares trading decisions
Felicity Thomas, a senior private wealth advisor at Shaw and Partners, says emotion can drive rash investment decisions.
For example, the fear of missing out (FOMO) can prompt people to buy ASX shares that are rapidly rising instead of buying them based on fundamental analysis.
She says:
Emotional investing often leads to poor investment decisions, like buying shares during euphoric phases [for the market] and selling low during panic phases.
A lot of investors want quick wins but it is important to maintain a long-term perspective.
Despite short-term volatility, history has shown that the share market tends to grow over time.
Thomas says patience and a disciplined approach can help ASX shares investors stick to their investment plans.
As a young investor, Thomas only invested money she did not need for living expenses.
She also kept some cash on the sidelines.
There are pros and cons to keeping some cash in your investment portfolio.
Today's high interest rates mean cash is certainly earning better returns than in previous years. However, inflation — which erodes the buying power of cash — also remains high.
