This recent correction has reinforced my perception that a strong mindset is required for investing. We have always heard psychology is an important part of trading, but not so in investing. I begged to differ as an investor also needs to manage his emotions in a market correction, just as similar to a trader having a drawdown on his capital.
The recent Japan Earthquake crisis is a good example. The markets around the world were reacting to the Japanese stock market, coming down with the latter. I cannot say how much relation or business dealings did the foreign companies had with Japan, but locally, there were some stocks not related to Japan at all, but came down as well. Unless you are a believer of the Butterfly Effect – A butterfly flapping its wings in say China can create ripple effect and cause a tornado in Brazil, I do not think the Earthquake is going to have a big impact to these companies not related to Japan, or even be affected by the potential spread of nuclear dust.
The price of an asset is determined by mainly supply and demand. Price changes are caused by changes in supply and demand. With bad news like the Japan crisis, demand for stocks would dropped as investors perceived troubles and decided to take a more conservative measure by selling the securities as fast as they can. In the market, not all the investors are equal – investors have different investment objectives, holding period, psychology, evaluation of the current market situation etc. This means that some investors may be spooked by the news and sell, but there may be other investors who see this as a temporary reaction and would like to hold through the period. This is especially so when the volume is thin and yet prices are coming down. This suggests that small retail investors are still selling stocks and but at a lower price which other investors are willing to buy. The number of shares transacted on 17 Mar 11 was 1208 million, and on 18 Mar 11, it was 1143 million. Comparing the average shares traded per day in Jan 11 and Feb 11 were 1810 million and 1342 million respectively. Until a time when the weak investors have sold the stocks, the market will only consist of strong investors (when I mentioned weak or strong investors, I am referring to their psychology). These strong investors would not want to sell these stocks at depressed prices, and eventually investors who want to buy from them have to bid higher, resulting in rising stock prices. And this is how a market recovers from the correction.
As long as the majority of the investors do not perceive the market as doomed, the market should be able to take this correction and resume its bullish path.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.