Investor Psychology 101 (and the Cycle of Doom)

Stock market investors are funny creatures. Every few years, they go through the same psychological and emotional rollercoaster as they ride the ups and downs of the market. 

A market cycle classically goes through 5 phases: 

1. Stocks go up 

At some point, investors join the fun because stocks are consistently going up. They don’t want to be left out. So they buy stocks (or mutual funds) and enjoy the ride up. 

Stocks go up, and investors talk to their friends. Friends talk to friends. And friends don’t want to be left out, so they buy! 

2. Stocks keep climbing 

The stock market follows the basic rules of any market: when there are more and more buyers (i.e. demand goes up, while supply remains the same), prices can only do one thing: climb higher. 

Everybody buys, driving valuations to sometimes ridiculous levels. Companies that make no profits whatsoever are priced at unsustainable levels. 

3. Stocks reach the top 

It sure feels good to see one’s portfolio grow day after day. So people buy more. They “buy at the top”, i.e. at the worst possible time. When a stock goes up 5 or 10% in a single day, it’s exhilarating. At some point, we enter bubble territory… 

You feel like a financial genius. Everything you buy turns to gold! What could possibly go wrong? 

4. Stocks go down 

Then something happens. The bubble pops. It always does. It could be a “black swan event,” i.e. an unlikely, unpredictable event. 

Examples over the past 2 decades include the 9/11 attacks, the real estate crash and the COVID pandemic. In turn, the stock market goes south. Stocks plummet. Everybody sells. 

5. Stocks reach the bottom 

Panicked investors keep selling more and more of their portfolios. Everything is in the red. It’s painful to watch. So people sell more. They “sell at the bottom”, i.e. at the worst possible time. 

At some point, it feels like stocks can’t possibly go lower. So investors start to buy stocks again, timidly at first… 

And the cycle starts over. 

1. Stocks go up 

At some point, investors join the fun because stocks are consistently going up. They don’t want to be left out. So they buy stocks (or mutual funds) and enjoy the ride up. 

As of this writing, the stock market keeps going up. Investors feel great. They feel confident. They think of themselves as brilliant stock pickers. Please remember that everything that goes up, eventually goes down. 

Buyer beware…

Phil Zeltzman, DVM, DACVS
Meredith Jones, DVM
Co-Founders of Veterinary Financial Summit