In bear markets or bull markets, investors tend to do the exact opposite of what they SHOULD do. Unfortunately, humans have been conditioned since neolithic times to run away as fast as we can from risk, screaming at the type of our lungs, "Do not go there! There is a BEAR over there! And he's baring his big ugly teeth! Everybody RUN!"
Thus, when markets get hairy, retail investors tend to always overshoot the mark and overcompensate for their losses. In other words, in risky markets, we are more likely to do what we know we should not. We buy high and sell low. It makes us feel better. After all, there is a Big Bad Bear RIGHT OVER THERE. 👆🏼
This phenomenon is the classic "moment of despair" that I referred to in my article last week, "On Capitulation and Bitcoin's Bloody Black Friday Weekend." If we see any more downside from here in the crypto markets (and chances are high that we will), it will be most definitely related to this investor psychology.
In order to be better investors, we have to intimately understand our own personal relationship to risk as well as our own primordial urges as a species. The fight-or-flight response conditions the way everyone responds to stress. There's no way around it. So we just have to understand it. When we perceive stress, our body's sympathetic nervous system initiates a series of automated physiological responses: dilated pupils, elevated heart rate, pale skin, and body trembling.
The release of a whole flood of hormones mostly causes these physical reactions. The main hormone that is secreted into the bloodstream is adrenaline, which basically makes a person act like they have drunk a whole case of Red Bull. The more stress you perceive, the more adrenaline your body makes. Why?
The adrenaline helps you fill your lungs with air and pumps blood to all the extremities of your body so you can run away from THAT BEAR. 👆🏼
So it makes sense that in a bear market, most investors are running away as fast as they can. But what happens in a BULL market? In that situation, which cryptocurrencies experienced all throughout the latter half of 2017, retail investors don't even think about risk. It kinda looks like this:
Do you see that little tiny four-letter word below the bull? That's risk. And in a bull market of screaming gains where even the newest noob is pocketing 400% returns, that's what risk is. A four letter word that you dare not mention.
That's the unfortunate part. In financial markets, risk is actually the highest when prices are relatively high and no one is talking about risk. Everyone around us is doing it. It's as if they are all saying, "Come on in! The water is fine!"
We as investors have to condition ourselves to do the exact opposite of what our hormones want us to do. We know what we have to do. The greatest investors of all time have told us over and over again exactly what to do.
First, there was Lord Rothschild:
Then it was Rockefeller:
And finally, we have Buffett:
These are the best investors in the history of mankind. They all echo this same sentiment. Do the opposite of your fight-or-flight reaction. Yet, time after time, in bull markets, retail investors never take their gains, almost always top up their investments at the height of the bull market, hold on to their losses for far too long, and eventually sell at the worst possible time at the very nadir of the market.
How can we avoid the fight-or-flight trap?
Investors must familiarize themselves with their own most intimate, visceral emotions. Study and reflection may help you to dive deep into that abyss. When you do, you turn the bear from that toothy, violent fella above into a cute cuddly teddy that you can deal with.
Remember that it's better to
Run toward the Bear and flee from the Bull.
That's the essence of contrarian investing.