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Fear, Greed & Panic!

There is a difference between investing in the stock market for the long term and investing in the stock market short term. The short term is getting in an out daily but at most over a few weeks, this if often referred to as day trading. Longer term investors may be invested for 3-5 years or more.

 The main difference is that there is an attitude shift required. Although both investments are still often in shares the perspective from which you view the investment should be worlds apart.

We can explore this difference by looking at shares in a little more detail. Lets take a start up business. There are many people in Ireland at the moment setting up their own business. When you do this it requires an injection of cash at the start to get the show on the road. You’ll need money for stock, deposit on the rent, stationery, sales brochures and so on.

The only reason you would put this money in now is because you believe that the business will be successful and you will get your money back plus profits. Now imagine you trade successfully for a few years. You might want to expand, replicate your success in a neighbouring town. So you decide to take on an investor. Usually the source of this investor is one of the three F’s, friends, family or a fool.  

Whomever it turns out to be, they put the money into the business for the same reason you did because they believe they will get their money back plus a percentage of the profits you generate.

Ten years down the road, having brought your brother on board 5 years ago, the product is a roaring success. You are successfully selling into the UK and Europe and all looks good. But you know the product would sell really well in the states.

But selling into the states means going big time, you’ll need serious capital and unfortunately the family well isn’t that deep and certainly there is no fool big enough around. That is when you consider an Initial Public Offering (IPO). You are going to float the business on the stock exchange.

You’ll need to decide where you want the company to be listed, in other words on what stock exchange will people go to buy your shares.

So you float the company on the Irish Stock exchange.  The big question is why will people buy your shares. This is where the psychology of investing splits. Admittedly everyone will invest for the same reason you and your brother did because they believe that they will get at least their money back plus some share in the profits the business generates.

The shorter term investor has a slightly different agenda. Each day the share price of a company reflects exactly, not roughly or approximately but exactly what the market believes that share is worth. Lots of things come into play when deciding the share price but ultimately it is down to demand.

If the share is in demand the share price goes up as more and more people buy it. If there are more sellers than buyers then the share price will go down as the sellers have to lower their price to meet the purchase price being offered by others.

But what drives the demand or lack of it. For the short term investor lots of things. But I think it can be captured in three words. Fear, greed and panic. Firstly the shorter term investor will invest for fear of missing out on something big, the next big win. Once they are in they can often hang on too long as the greed kicks in and then it goes too far.  The share price begins to falter and all three emotions kick in at the same time and they panic and sell off pushing the market down even further.

I appreciate that this is an absolute dramatisation but it is a little insight into how markets can move. You need to consider day trading and the markets’ reaction to news in the same way a young child reacts. When they get good news they are running around the garden hands flapping above their head. When they get bad news or even better some gory news it is tremendously terrible.

The markets provided us with proof of this in the last year. We have just witnessed one of the best stock market rallies in history, US markets rose by about 50-60% with Asian markets rising over 100%. This is great when you ride the wave but it is probably fair to say they went too far too fast. We then witnessed a correction in the last few months some dropping by 15% in 8 weeks, again is too far too fast.

If you have the bottle to ride the markets up and down in their erratic fashion by all means go for it. But remember if you can double your money in a day you can also half it the next day.

Longer term investors are much more sedentary, they invest in the market today with the bigger picture in mind. The question you need to ask is do you believe that the company you are investing in will be producing more or less profit in five years time than it is today, will the share price be higher or lower.  

You can afford to strip out all the day to day news flow that pushes share prices up and down erratically. For the long term investor the only real news that matters is the news that will be remembered in 5 years time.

Longer term investing in my opinion is much more reasonable and less cruel. You can take a view on the world and where it is going to be in 5 years time. In my opinion never before has that decision been easier than right now. The World is certainly not broken, it’s not fixed yet either hence the turbulent few months ahead but it is fair to say that in five years time the world will be in better place than we are right now. So when you see a dramatic headline that has had a huge impact on the day traders that’s your signal as a longer term investor to get in and avail of the discount.

About the Author

Eoin McGee is the owner of Prosperous Financial Services, an independent firm regulated by the financial regulator as a multi agency intermediary and mortgage intermediary. He has over 10 years experience giving advice to both individuals and companies in relation to their finances, he can be contacted on eoin@festinosolutions.com,  045 841 738 or 087 6 44 55 33.