“Never fall in love with a share because it won’t fall in love with you” is ancient stock market advice. But there is growing evidence that investors ignore it, and are in fact swayed by their emotions.
“investors enter into emotionally-charged relationships with the stocks they invest in,” says the University of Miami’s Alok Kumar. He and his colleagues compiled an index of market emotion based on how often market reports used words describing emotions, and found that some shares – generally smaller growth ones – were more sensitive than others to this index. “investors are attracted to stocks that have emotional ‘glitter’” says Professor Kumar. Emotions, then, can drive prices.
Other recent research corroborates this. Alex Edmans at London Business School and colleagues show that there is a significant correlation across 40 national stock markets between weekly equity returns and the emotional content of that week’s top 200 songs on Spotify. Stock markets do better when a country is listening to happier songs than when it is listening to sad ones.
This fits with earlier evidence. Adriana Breaban and Charles Noussair at Tilburg University got people to trade artificial assets under laboratory conditions whilst using face-tracking software to gauge their emotions. They found that positive emotions led to buying and over-pricing whilst fear led to selling. “Emotions and market dynamics are closely related” they concluded. And the University of Verona’s Chiara Nardi and colleagues have found that heightened emotions of almost any sort – anger, happiness or sadness – lead people to take on more risk.
All this reinforces the idea that share prices are driven not merely by a cool-headed assessment of companies’ prospects but also by external factors that can influence investors’ mood. Earlier work by Professor Edmans found that national stock markets fall on the after a country loses an important football or rugby match, for example. And David Hirshleifer and Tyler Shumway have shown that, across 26 different countries, stock markets tend to do better on sunny days.
The most important evidence here – because it has implications we can actually trade on – is of course that stock markets have a seasonal pattern. Ben Jacobsen and Cherry Zhang have shown that most markets, since they began, have done better between Halloween and May Day than from May Day to Halloween. The All-Share index, for example, has given an average total return since 1966 after inflation of 7.9 per cent from Halloween to May Day but has lost an average of 0.6 per cent from May Day to Halloween.
A team of Canadian economists have pointed to a reason for this. Investors, they say, are prone to the winter blues. As the nights draw in in the autumn we become anxious and depressed. That pushes share prices down so that by around Halloween they are undervalued and so subsequently recover. And in the spring the lighter evenings improve our mood and so push up share prices so far that they become over-priced.
The evidence therefore vindicates Warren Buffett’s famous advice. What investors need, he has said, is not high intelligence so much as “emotional stability”, the ability to stay calm when other investors are too panicky or too euphoric.
But how can we achieve this? Many people find that meditation successfully calms them down and improves their mental health. It does not, however, make us better investors, as recent experiments by the University of Kansas’s William Bazley has found. He got people to do five minutes of mindfulness meditation. And he found that those who did so tended to take less cash now when offered a choice between money now and money in the future. He also found that people were more likely to sell shares they had made a profit on after meditating. Meditating, it seems, makes us more short-termist.
There’s a reason for this. Mindfulness encourages us to focus upon the present because, as Arsene Wenger said, “the only moment of possible happiness is the present. The past gives regrets. And future uncertainties.” In doing so, however, it causes people to discount the future more heavily, which means they save less and take profits on winning stocks when they should not.
Perhaps there’s a simpler solution. We should never take any financial decision when we are in any sort of emotional state at all. And having made a decision we should, where possible, give ourselves a few days before acting upon it. Herodotus reported that the ancient Persians would take decisions twice, once when drunk and once when sober. We shouldn’t precisely follow that lead, but we should learn from them to separate our decisions from our temporary emotional state.
We must also be aware that our financial judgments can be swayed by extrinsic factors such as the weather, time of year and our private lives. Our self-image – which is buttressed by both our self-regard and the economics textbooks – is wrong. We are not rational, cool-headed calculating maximisers, but rather creatures swayed by passing moods.
