March 2011

Moody markets?

When the markets are on the rise, we sometimes say that good news has put them in a buoyant mood. And when things aren’t going so well, they’re… “depressed”. Sound  familiar?

The graph below might remind you of your own emotional ups and downs over the past three years. In fact, it simply shows changes in the Toronto Stock Exchange’s S&P/TSX index, with its very high highs… and very low lows. But if it happens to mirror your emotional state, rest assured that it doesn’t mean you are unusually sensitive.

Like a drug

According to a number of researchers working in a branch of neurological science known as “neuroeconomics”, a financial gain triggers activity in the same areas of the brain as physical pleasure or certain drugs. In its own small way, the effect is not unlike that of cocaine, which triggers the release of dopamine and creates feelings of extreme confidence. Conversely, a financial loss, especially after a long period of gains, can cause anxiety that feels a bit like withdrawal.

Beyond fear and greed

This isn’t to say that the investment world behaves irrationally, but these studies allow us to understand that while the markets reflect rational behaviours most of the time, there are moments when irrational emotional reactions take over. This irrationality is a direct function of the wealth creation process:  the greater the creation of wealth, the more the markets tend to conceal risk. On the other hand, the greater the destruction of wealth, the more this exuberance is replaced not by simple fear, but by a contagious anxiety and behaviours that are just as irrational. Unlike fear, which has a source, anxiety tends to be unspecific:  it invades a person’s whole life, reduces the ability to listen and affects one’s sense of proportion.

How can you protect yourself?

Nothing could be more natural than feeling anxious during a period of high volatility such as the one we went through two years ago – not to mention the ones we will inevitably experience in the future. However, there are ways to control one’s emotions and prevent oneself from making regrettable decisions. Here are a few:

  • Did you have a plan? Did it assume that you would have financial gains or losses due to stock market fluctuations every year, within certain boundaries? Go back to that plan. Sometimes, what seems exceptional was actually predictable – and predicted.
  • Don’t let negative emotions turn into anxiety. If you start to feel over-anxious, resolve the issue right away. Get something out of your anxiety, once and for all, and get to the bottom of the problem with your financial services professional.
  • Make it a habit to see both the positive and negative sides of every situation. When things are going well, look at the dark side. When they’re going badly, look at the bright side. Learn to keep market upswings, as well as declines, in perspective.
  • Get moving! Exercise, yoga, recreational activities – all trigger mechanisms that can break the anxiety cycle and help you look at the reality of the situation in a more rational way.

In short, whether the mood of the markets is buoyant or depressed, the main thing is… not to be that way yourself.