The Market and Investment Psychology
It is said that investment in stocks is 20% strategy and 80% psychology, and I couldn’t agree more with this statement. In my fourteen year of experience of investing, I have learned the power of patience and rational thinking is the key to successful investing in the market.
Stock market investors are either too greedy or too fearful but seldom rational.
Most people lose money not because of poor choice of stocks but because of lack of discipline, patience and rational thinking.
I came across a book few years back that had a significant impact on my investing psychology and reshaped my approach to investing.
The name of the book is “Extraordinary popular delusions and madness of crowds” by Charles Mackay”.
It is by far the best book written on crowd psychology and herd mentality and how popular beliefs can spread fear, greed and how we start following the herd instead of thinking rationally.
About the Book:
Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay is a study on crowd psychology and is extremely relevant to the present day, despite being written back in 1841. It explores how easily we can be misled and how illogically we can think when popular opinion influences us.
The central theme of the author of the book is how it is a tendency of humans to develop herd mentality, and to act to certain stimuli.
The author of the book highlights many historical events from the past, where various manias, asset bubbles took place and how people lost their fortunes just because they followed the herd blindly without thinking rationally.
One of my favorite events from the book on how greed and fear makes us do stupid things is the Tulip Mania
The Tulip Mania,herd mentality and the story of fear and greed:
Europe, back in 1600s, a simple tulip flower was seen as a novelty item and sign of prosperity. The tulips became a status symbol. Since it was popular among high class people, willing to pay higher price to get their hands in a tulip flower, the price of tulip bulbs started rising.
Soon a lucrative business became a mania. People willing to make a fortune out of it purchased tulip bulbs at an exorbitant amount of money. As far as 12 acres of land was being for a single bulb.
As the prices went up further, it fueled more speculation to a point where even poor people started investing their life savings into this just because of the fact that everyone was buying them and making profits, the entire system was now driven by greed, the logic and rational thinking were thrown out of the window.
By the time this madness finally died, lot of people had already lost a lot of money and finally the price of tulip bulbs came back to their fundamental value, which was almost zero.
Lot of this madness still exists today in the stock market, its called herd mentality.
When people find a stock that is continuously rising and making money, they start chasing it, expecting to get rich overnight. In an attempt to get their hands on the hottest stock, they end up paying too high price for it (just like the tulip bulb), only to regret their decisions later.
The author of this book, explains how to differentiate between an asset’s market value and its intrinsic value, so that you don’t get swept away like others and succeed by independently developing your own plan.
This is just one of many historical incidents written in the book, you will find lot of such incidents such as the Mississippi company asset bubble where a person named John Law, which is another interesting read on how our current banking system called the “fractional reserve banking system” works and how vulnerable we are to any black swan event.
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he book was written almost 250 years back. Reading this book will make you will realize, no matter how much we have progressed in terms of science and technology, there has been a little change in the way we behave, especially collectively.
One of my favourite quotes from the book is “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
Charles Mackay catalogues some of the irrational fads that have gripped mankind over the years, and you will find lot of incidents in the modern world(such as Japanese real estate bubble, the dot com bubble and the subprime lending bubble) which shows that the madness we see today is neither unique nor new.
So who should read this book? You must read this book not only because you want to invest, but those looking to understand the impact of herd psychology on common people and how it starts from an opportunity to madness and soon turns into a mania, will find this book very useful.
For those looking to invest in stock market or any other asset, this book in my opinion is a must read as it will help you in differentiating the wheat from the chaff and understand when the crowd is getting irrational.
Due to absence of copyright from the author, there are many cheap ripoff of the book available on Amazon, that is why I found a genuine link to the complete and unabridged version of the book, which you can buy using the link below: