Fear, Greed or Prudence? Reacting to Market Volatility

The market has bounced back with vengeance. And then it dropped again. It was certainly a very volatile week.

On Monday, the market rebounded due to expectation of rate cuts. Then on Tuesday it dropped again. On Wednesday, it rebounded again due to Joe Biden’s performance on Super Tuesday. Then on Thursday it dropped again when California declared a state of emergency.

How should we react?

#1 Fear

Fear, a natural primal instinct, has helped our great great ancestors survive.

When we sense danger, the two fear hormones Cortisol and Adrenaline are secreted giving us heightened awareness, more blood pumping throughout our body and more energy to fight or flee.

Likewise when the market drops, the fear response kicks in and suddenly you felt like you need to do something – sell off before it is too late.

That is the danger of fear.

Fear is currently the main emotion driving the market now.

CNN Fear & Greed Index

However as I mentioned in my previous post (Panic in the Time of Corona), when we see the market falling, it is already too late as all the bigger financial professionals had already sold off.

Odysseus and the Sirens

In Greek mythology, there was a tale of Odysseus who wanted to hear the sirens knowing that their sweet song will lure sailors to their death. So he had his crew plug their ears with beeswax and ordered them to tie him tightly to the mast of his ship and not let him go no matter how badly he begged.

Long story short – he survived

So if fear is your main emotion, we need to do something just like what Odysseus did. If you cannot handle it, try to remove it or get someone or something to stop you from taking rash decisions.

We could avoid market news at all costs and be blissfully ignorant.

Or get a financial advisor to help you stay the course no matter how bad it falls.

Or maybe if your online brokerage happens to fail during a market crash, thank them instead because they might have stopped you from panic selling.

Remember, market corrections are normal. Ignore the short term losses and stay focused on your long term goals

#2 Greed

Fearful when others are greedy and greedy when others are fearful

Warren Buffett

The other reaction during market volatility is greed.

There are many investors, the more risk-seeking ones at least, are increasingly looking forward to a market crash.

Why? Because when stock prices are falling, they can scoop up some great bargains.

During the last week of February, I had read so many finance bloggers who are just waiting for market crashes to empty their war chest. Even president Trump attempted to give some financial advice – ‘Buy the dip’.

The situation will get better, won’t it? After all, governments around the world are ready to react to this and boost the market.

However, the COVID situation is quite different from all the recession signals that we had seen in the couple of years. Those are related to economic activity or fiscal or monetary policy or financial fraud or bubbles.

This time, this cause of concern is due to a virus – a health issue. And yet, central banks all around the world are sticking to their standard vaccine for market issues – monetary policies.

Can monetary policies solve all problems – including health related problems?

Problems with Demand

Since Feb, there has been a huge demand drop for travel, tourism, retail and luxury. This is due to the infectious nature of this virus which is preventing this.

For example, Hong Kong will be giving cash handouts to boost spending.

Monetary policy or cash payouts can make goods and services cheaper, but I do not think the demand drop is due to price of the goods and services. It has more to do with fear and uncertainty.

Also, it also has to do with quarantine measures, travel advisories and travel bans.

It is not all doom and gloom, if you are in the business of selling consumer staples or toilet papers, there is no shortage of demand there.

Problems with Supply

Since the first few weeks of Feb, the world has been impacted by the closure of numerous factories all across China (COVID-19 Impact on Market). Automotive manufactoring and certain industries are struggling to get parts.

Stimulus will not get people back to factories working. The situation on the ground are preventing them from resuming their work.

Cheaper credit is certainly welcomed especially the smaller factories as they are more affected by COVID-19 disruption to their business.

So there may be some help to keep companies afloat but not enough to keep the assembly lines from running.

Problems with People or Governments

I think the largest unknown is how other countries or people in other countries respond and contain the virus.

Some governments have a lot of authority and will not hesitate to take drastic measures to restrict entire towns or regions. Others not so.

Some governments are very organized and have plans or procedures in place. Others not so.

Some governments have enough medical resources to treat and contain while others are not ready to handle.

The huge spikes in Italy, South Korea and Iran showed how quickly the virus can spread and how the virus can grow at different rates in different countries (or luxury cruises).

We still do not know whether the situation will get better and certainly more money cannot cure this outbreak.

Good Idea to Buy the Dip?

Given all these uncertainty, it is still very hard to say for sure we had reached the bottom and the situation can only get better.

Trying to buy the dip will be like catching a falling knife – it might cut you.

So, as in the previous point, stick to the long term goal, do not be greedy for short term profits by timing your buys.

#3 Prudence

Sometimes, the best reaction is just to wait. Wait till you have more information to make that informed decision.

Even when markets are dropping and many buying opportunities present themselves, you need to take into account how much cash you will need should a recession happen and you run out of a job.

Only invest funds that you can afford not to use. Keep the rest as cash for your liquidity needs. Those cash reserves are your plan B.

Then you can use what is left of your funds to help accumulate more assets at a cheaper price now and hope for growth in the future.

It has been a recurring theme throughout this post – focus on the long term.

That is why it is crucial to have a plan, build a diversified portfolio and stick to it.

We cannot predict the future, so stay in the market because you never know when it will plunge or when it will rebound.

Conclusion

As we journey on this crazy market rollercoaster ride, stay seated by staying in the market.

Buckle up with your seatbelt of diversification.

Stay the course of your plan and keep on the tracks. There will be ups and downs in this ride.

Close your eyes to market news when the roller coaster plunges down or hold your financial advisor’s hand when you are afraid.

Enjoy the ride down because all that momentum gained from buying assets at a cheaper price will help you go back up, eventually. (Technically it is potential energy converting into kinetic energy but this is not a science blog)

All too soon, the ride will be over and the next thing you know, you will be on another ride again.

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Author: Fatty's Finance

Finance is like health. It becomes an issue if it is not well maintained. I want to help you get back in shape!

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