How mum and Pop Investors React Inline With Investor Sentiment

A week ago I published a post called My Outlook on the Markets #1. In the post, I also published a great graph, so here it is.

In this post, I will explain to you exactly how the average American, mum and pop, fits into the whole investment cycle.

  1. Optimism. The average investor is looking from the outside to the inside. Despite the rising market, he isn’t sure if he should buy or not.
  2. Thrill/Europhia. This is exactly where mum and pop buys. He or she gets caught in the “this time is different” herd, and buys, believing that stocks will go far higher up.
  3. Denial. mum and pop (the idiots they are) are thinking about Buffett’s “be greedy when others are fearful” PR line. So they think they’re being smart, and decide to buy here, showing their ignorance by saying “if the markets fall lower, I’m in this for the long term, so I’ll hold.”
  4. Panic/Capitulation. This is where the average investor sells. He or she starts following the herd mentality that “there is no bottom in sight”. This is exactly what happened in 2009. The public decided to sell in early 2009, only months before the bottom.
  5. And then the cycle repeats itself. The public is scared to death by it’s recent buy high/sell low experience, and hence wait for a long time. By the time the public plans to buy again, the markets are already in the thrill/europhia stage. If you want to know how to avoid such painful mistakes, please check out my post on How to Invest in a Panic.