Everyone tries to wonder what drives the market? Why does it react daily? And who is responsible for daily moments in the stocks and indices? The answer to all of your questions is Market Participants. Through understanding the market participants psychology I've observed something common in all the market participants. This blog will help you understand the psychology of the market participants.
What I've observed and seen is there are specifically 4 types of Market Participants, or for that matter in any field. I call this the perception pyramid. Wherein we divide the people in 4 categories according to their type of perception.
The 4 types are factful, knowledgeable, intelligent and cognizant.
For your better understanding let us take the recent example, Inflation! The market has recently created a theme around that. If you open any news channel or newspaper everyone, everywhere is talking about INFLATION! So let's say, there is a headline in the newspaper that “inflation is high”. And now let's see how each category will understand it and react to it.
I call the first category people as, factful. They will register the news in their mind but without actually understanding what inflation is. They will just notice it and move forward, ki theek hai hai abhi inflation, these people will also only read the headline half baked and half known news and create an anchor in their mind which is the worst thing. I believe borrowed money and borrowed knowledge are both destructive. So the actions of these category people will be most irrational, they will take actions without actually thinking. Because they have not understood the actual fact, they will only react the way which is told by the news providers. It is not wrong to do as per what news agencies say, but the actual wrong is when you take actions without independent thinking. If the news channel says buy, they will buy and if they publish sell calls, they will sell. This is what leads to the herding. A majority of people lie in this category.
The second level in this pyramid are called knowledgeable people. If they read the same news they will read it and register it. These people know what inflation is but not to the fullest. These people can remember facts, they can speak out loud in front of people and will make other people think they are smart. They can be called factful parrots continuously repeating the same headline they read. These people lack decision power, they will not be able to form any conviction out of what they have read because they have shallow knowledge about that topic. These category people will not react to anything good or bad, they will wait and do according to what the market is doing. Basically they will follow the herd. They can never take contrary positions. The only difference between the factful and knowledgeable is that knowledgeable people know what inflation is and factful don't..
On the third level we have intelligent people. Now we come to that 5% of the crowd that actually make money by actively investing their capital. These are the people who read, understand what inflation is. They will know that in inflation the prices of raw material increase and the margins of the business can be affected therefore affecting their earnings. These people can form their own opinion and will act on their decision swiftly. They may be able to take positions against the crowd's irrational actions. But they are kind of impulsive, they won't be able to take advantage to the fullest because they will not understand the consequence of consequence.
The fourth Level are the aware or cognizant people who know the facts and interpret those facts in the longer term. Just like being aware is the top most priority spirituality, being cognizant is the top most priority to become a successful investor. Both of them mean the same thing, taking action without getting repulsive. They know that Inflation will reduce earnings but not in the longer term. If you have companies that pass on their increased price to their customers your earnings are inflation proof. The only difference between intelligent and cognizant category is, the people in cognizant category are thinking one step ahead or what we call second order thinking. The cognizant and visionaries have similar traits. When the herd sells they mind out with the news of inflation, these category people buy when the stock is duped to the extent that the price comes below its intrinsic value. Only 1% of the crowd comes into this category.
So that is what makes an ordinary investor an extraordinary investor. Second order thinking is not achieved by everyone, there is noise, biases and blind spots that keep everyone from acting wisely. But extensive reading and understanding the things as they are without any noise makes a person a second order thinker. We'll read the same newspaper, you, me and the best fund managers in India but all of us have different perceptions about reading the same line. You check out where you fall into this pyramid?
For any suggestions, comments or queries you can contact me at axanoun@gmail.com
Thanks,
Mrunal from axanoun.