4 July 2014
What does a nice, hot, deep bath have to do with the investing or trading in any financial market - whether the Rand, other currencies, gold, commodities, bonds, stocks, etc?
More than you may think.
In fact, it probably could be the biggest lesson you've learnt since reading Dr Seuss' The Bike Lesson many years back...
Sometimes learning what NOT TO DO is as important than learning what TO DO.
And so it is with the Hot Bath Syndrome.
You see, when it comes to investing, trading or exchanging in a financial market, the average person acts as if they are about to take a nice hot, relaxing bath on a winter's evening.
Imagine the scene...
You test the water, but mostly it is too hot for your liking - or too cold. And so you adjust the taps. Even if it is just right, you wait on the side for it to fill up some more.
Approaching half way, it is likely around the right temperature and deep enough to get in, but what do you do? If you are like most of us, you still wait ("climbing into a half-filled bath would leave me half exposed to the elements and at risk of catching a cold - and I want to be completely comfortable when I get in.")
When the bath is nearing that nice, inviting, full look, you do some last testing and adjustments and - finally - you get in.
And immediately, you feel so good, as you simply lie back and soak in that rising warmth all around you, with virtually no exposure at all to the harsh elements.
There is nothing quite like a warm bath - to feel the total warmth around you, and feel your every muscle relaxing, and all the day's tension, anxiety and concern draining from every pore as each minute passes.
You are totally complacent, and at peace with the world...
...almost lulled into a drowsy, self-satisfied semi-slumber.
And then something feels different – the water isn't that warm anymore.
So you fill it up some with some more hot water. And then a bit more, until it is as full as it can possibly be.
And you lie back and relax once again – life cannot get much better than this – a hot, warm, deep, relaxing bath.
But it doesn't stay that way...
...It starts cooling down.
But...you are still in that warm fuzzy zone from when it was hot and full, so you sink down up to your neck in the water –
And still it cools down...
...And still you don't get out.
No, instead, you pull out the plug, and stay in the bath as the water drains away around you. And, strangely, you almost enjoy the different sensation after that nice hot bath, which is still very much in your mind’s eye.
Until suddenly, when the bath is almost drained of water, you wake up to the fact that you are sitting – totally exposed and cold – in a completely empty bath.
And that's when you finally get out.
I am sure you can relate. But why on earth do we do this?
Why get in the bath when it is full and hot? And get out when it is cold and empty?
Why not get in while it is hot and filling up? And get out before it starts cooling down?
Well, here's the rub – as irrational as this human behaviour may seem, our natural instinct is to approach the market in exactly the same way:
The market moves up, but still we are not convinced or comfortable – we don't want be caught and exposed if the market falls again. So we wait. And the market moves further. But we wait still – we want to be sure we are doing the right thing.
Finally, we get the signs that we are looking for – the market has moved up nicely over a sustained period, and everyone you speak to reinforces what you are feeling yourself – the trend is now well-confirmed. And everyone is talking about it going still higher.
It's time to get in.
And it feels so good, because you didn't get in when there was still the chance of exposing yourself. It feels so good to be in a market that is mature and is looking to continue.
We feel at peace and complacent...lulled into a (false) sense of security.
And then the market drops a bit. “No problem,” we say, “just a chance to top up a bit.”
Then, the market drops sharply – and the mood really starts cooling.
It’s uncomfortable!
But we don't get out – no, we still have that vision and warm fuzzy feeling of being in a nice, heated up market that will continue for ever. And so we stay in the market, in the hopes that our good fortunes will return.
Which they don't.
And by now, we are almost numbed at the thought of doing anything. So we don't.
Until suddenly we wake up and realize the market has dropped way beyond what was comfortable, and persons are now talking about it falling even further.
Eventually, it is too uncomfortable to stay in any longer.
We capitulate and get out...
...just when the market has bottomed and is about to start a new swing up.
And unfortunately, such is the syndrome that is suffered by the majority of persons involved in financial markets: – getting in when we should be getting out, and getting out when we should be getting in.
As an example, remember how Gold was all in the news in 2011?
Click to see full size... | See here for video
The above chart of Gold by Elliottwave International illustrates this irrational but predictable behaviour very aptly, showing headlines during the final run up to the high, by which point 98% of the market were expecting Gold to continue rising strongly – with some ‘experts’ forecasting $10,000 per ounce!
We can see clearly what happened from that point on!
And this clearly illustrates why 80-90% of financial investors and traders lose money.
I couldn't find the origin, but perhaps that's where the phrase "to take a bath" was originally coined – whatever the origin, it is pretty apt, when put it in the above metaphorical context.
So, what is the cure/antidote to this syndrome?
- Firstly, we need to realize that we will default to this mode of emotional-based behaviour unless we have an objective, informed, educated knowledge and view of the market.
- Secondly, we need to know ourselves and recognize when those two villains, fear and greed, raise their heads, and to take action based on our analysis, despite how we are feeling.
- And thirdly, to realize that when everyone is agreed on where a market is going, it is a clear indicator that it is likely to do just the opposite.
As Warren Buffet aptly has put it,
Be fearful when others are greedy...
...and greedy when others are fearful"
And perhaps we should add - "...else take a bath"
See here for a video with more examples of this phenomenon in the property, gold and stock markets.
As always, would appreciate your feedback and comments.
To your success~
James Paynter
P.S. And if you are exposed to Rand currency fluctuations, and are feeling frustrated by the Rand's wild movements, let us assist you by giving you up-to-date forecasts so that you can better time your transactions, and save you time, money, stress and effort.
