Value Investing: Tools and Techniques for Intelligent Investment

Chapter 13. The Psychology of Bear Markets^[13]

The mental barriers to effective decision-making in bear markets are as many and varied as those that plague rationality during bull markets. However, in bear markets the primary role of emotion is particularly pronounced as the resulting fear and shock short circuit more logical analysis. Experiments have shown that those that can't feel fear behave more rationally in the face of loss than those who can. Perhaps many of the extremes we experience during our moments of both euphoria and revulsion could be avoided if only we heed the words of King Solomon's advisers 'This too, shall pass'.

• It is a cliché that markets are driven by fear and greed. However, it is also disturbingly close to the truth. Having spent the best Part of a decade exploring the psychology of bull markets, it makes a refreshing change to examine the drivers of bear market behaviour.

• Fear seems to lie at the heart of the psychology of bear markets. The bad news for us humans is that within the brain emotion appears to have primacy over cognitive functions. Our brains consist of two different (although interconnected) systems. One is a fast and dirty decision maker (the X-system), the other is more logical but slower (the C-system).

• The X-system's output is often unchecked (or at least checked only too late) by the C-system. For instance, if I were to place a glass box containing a snake on the table in front of you, and asked you to move as close as you could to the ...