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The first thing to keep in mind is that in the overall scheme, inevitable short-term fluctuations in the market mean nothing. At the very least, they can make us uncomfortable or downright queasy as well as waste our time. At worst, high-frequency monitoring can lure investors into counterproductive actions that can end up costing them serious money. It is more effective to keep calm, carry on and work with professionals. Don't follow the Dow Jones daily and wonder whether your long-term plans are going off the rails.
After a first burst of excitement, keen buyers may reconsider what happens in a rally. Have external conditions changed enough to warrant such a powerful move? Meanwhile, investment fund psychology reinforces the surge. A majority of funds are restricted from taking short positions anyhow or from holding cash over a certain level. Others bow to peer pressure, seeing the herd on the same bandwagon. They know they can get away with simply keeping up.
Everyone has their own level of risk tolerance or risk appetite, which represents the uncertainty they feel comfortable taking when investing. But do they know their own personal level of risk comfort? Most people are unlikely to understand their true risk appetite until they are facing a serious potential loss; until they are staring at a monster decline, they cannot know whether they have the stomach for it. It is easy to assume that everyone has high risk tolerance in a bull market as their portfolios keep heading upward!
Like a traffic light, the CAPE metric flashes clear red and green signals. When the S&P 500 Shiller CAPE rises over a 30 threshold, the red light suggests that prices are becoming too elevated; when it sinks below 22, markets may soon see bargains. Sound idiot-proof? Remember it only speaks to expected future returns, so it is not a shortcut for timing markets.
To start with, successful investing means a reliance on a mix of mathematical applications and other factors, like economic, political and industry analyses. On the flip side, gambling can mean either games of chance, such as roulette or slot machines, or tests of skill, like poker and blackjack. And speculation occupies an intermediate zone between the two.
The fear of missing out on the latest hot investments is a primal emotion that can play havoc with investment portfolios. The irrepressible urge to keep up with the Joneses infects financial markets just as it pervades daily life.
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