Behavioural finance theorists believe stock-market bubbles are due to an overreaction to a positive investing climate. During the dotcom era, investors were said to be at the peak of optimism and many believe they were making rational decision by investing in stocks that had yet to generate earnings. The higher stock prices are, the more optimistic investors become. Likewies, low prices lead to pessimism. It can be difficult, even for the more experienced investor, not to get caught up in the prevailing sentiment of the market.
An indication that the investors are over- or under-reacting to eventsare when share prices fall by a large quantum aafter a hint of bad news, such as when financial institutions reported losses due to the defaults on subprime mortgages in the US. The American stock market fell after hearing about the losses due to the subprime sector. This created fear among investors and some will overreact. Investors usually start behaving irrationally when the market starts goin down.
WHAT TO DO
Revisit the basic principles of investing: asset allocation. To avoid getting caught up with irrational exuberance, investors should allocate their protfolio between strategic and tactical investments. Then, limit tactical investments based on "hot" themes to their portion for tactical investments.
Strategic investments offer modest but steady returns and should be held for the long term. Tactical investments offer the potential of quick but volatile returns and should on make up between 10% to 30% of your investment portfolio. How much tactical investment you make within this range depends on your risk profile.
Investors can avoid overreacting to bad news by anticipating periods of underperformance. As long as your stocks meet your long-term investments goals, don't worryabout outperforming the benchmark or your peers on a short-term basis. Stocks will move up and down. This is all part of an economic cycle.
Perhaps the best way to handle snetiments of optimism or pessimisms is to double-up oyur research. If your stock falls, look for reasons. If your share gains in value, also try and identify the cause. Only then can you make an informed decision on wether to sell or hold on to your investment.
An indication that the investors are over- or under-reacting to eventsare when share prices fall by a large quantum aafter a hint of bad news, such as when financial institutions reported losses due to the defaults on subprime mortgages in the US. The American stock market fell after hearing about the losses due to the subprime sector. This created fear among investors and some will overreact. Investors usually start behaving irrationally when the market starts goin down.
WHAT TO DO
Revisit the basic principles of investing: asset allocation. To avoid getting caught up with irrational exuberance, investors should allocate their protfolio between strategic and tactical investments. Then, limit tactical investments based on "hot" themes to their portion for tactical investments.
Strategic investments offer modest but steady returns and should be held for the long term. Tactical investments offer the potential of quick but volatile returns and should on make up between 10% to 30% of your investment portfolio. How much tactical investment you make within this range depends on your risk profile.
Investors can avoid overreacting to bad news by anticipating periods of underperformance. As long as your stocks meet your long-term investments goals, don't worryabout outperforming the benchmark or your peers on a short-term basis. Stocks will move up and down. This is all part of an economic cycle.
Perhaps the best way to handle snetiments of optimism or pessimisms is to double-up oyur research. If your stock falls, look for reasons. If your share gains in value, also try and identify the cause. Only then can you make an informed decision on wether to sell or hold on to your investment.
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