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Those who are into music (oldies to be exact) may recognize the title as a spoof of a song sung by The Carpenters called “Close To You”. As I was humming this tune innocently, the twist in the lyrics just came to me and I could not help penning it down as a posting; just please forgive the corny change in the original lyric which still manages to somehow rhyme ! For those who are curious, the original lyric is “Why do birds suddenly appear, every time you are near”.
The title actually refers to my observation that stock markets in general tend to rebound sharply and suddenly after a prolonged period of fear, trepidation and uncertainty. After some thought and some additional reading from investment and market psychology books, I have come to realize that this effect is actually rooted in expectancy and anticipation. Both are contributory factors which determine the tenor of the market and whether there is irrational exuberance or misplaced fear. I shall touch on the former first, move on to the latter then attempt to gel the two together to make a coherent argument as to why the mixture of the two has such a dramatic impact on the stock market.
Expectancy refers to expectations of certain events and their likelihood of occurrence will determine the magnitude of the psychological reaction. A good example would be expectations of a 50% jump in profits for Company A, based on Company A’s track record of good growth and also prudent and steady Management. Expectations would be high for the Company to grow its profits by more than the long-term average of 10-20% due to external factors as well, such as a booming economy, favourable economic policies or strong interest in that industry.
This is an example of expectations being pushed high as a result of a myriad of factors. The result is that if the Company reports a 30-35% increase in earnings, the result is a drastic sell-down in the Company’s shares as expectations were not met. This is also known as the “expectation gap”. The magnitude of a psychological reaction to an expectation gap depends on the strength of belief in the outcome, as well as the depth of difference between the perceived outcome and the actual result. The converse is also true for expectations of poor performance, but the reader should note that the resultant positive reaction is largely more muted than one composed of negative surprise. This is due to the previously mentioned over-reaction bias inherent in all humans, who tend to over-accentuate the negative and discount the positive. Read more...[caption id="attachment_2960" align="alignright" width="150" caption="Photo by Vincepal"][/caption]
Those who are into music (oldies to be exact) may recognize the title as a spoof of a song sung by The Carpenters called “Close To You”. As I was humming this tune innocently, the twist in the lyrics just came to me and I could not help penning it down as a posting; just please forgive the corny change in the original lyric which still manages to somehow rhyme ! For those who are curious, the original lyric is “Why do birds suddenly appear, every time you are near”.
The title actually refers to my observation that stock markets in general tend to rebound sharply and suddenly after a prolonged period of fear, trepidation and uncertainty. After some thought and some additional reading from investment and market psychology books, I have come to realize that this effect is actually rooted in expectancy and anticipation. Both are contributory factors which determine the tenor of the market and whether there is irrational exuberance or misplaced fear. I shall touch on the former first, move on to the latter then attempt to gel the two together to make a coherent argument as to why the mixture of the two has such a dramatic impact on the stock market.
Expectancy refers to expectations of certain events and their likelihood of occurrence will determine the magnitude of the psychological reaction. A good example would be expectations of a 50% jump in profits for Company A, based on Company A’s track record of good growth and also prudent and steady Management. Expectations would be high for the Company to grow its profits by more than the long-term average of 10-20% due to external factors as well, such as a booming economy, favourable economic policies or strong interest in that industry.
This is an example of expectations being pushed high as a result of a myriad of factors. The result is that if the Company reports a 30-35% increase in earnings, the result is a drastic sell-down in the Company’s shares as expectations were not met. This is also known as the “expectation gap”. The magnitude of a psychological reaction to an expectation gap depends on the strength of belief in the outcome, as well as the depth of difference between the perceived outcome and the actual result. The converse is also true for expectations of poor performance, but the reader should note that the resultant positive reaction is largely more muted than one composed of negative surprise. This is due to the previously mentioned over-reaction bias inherent in all humans, who tend to over-accentuate the negative and discount the positive. Read more...
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Those who are into music (oldies to be exact) may recognize the title as a spoof of a song sung by The Carpenters called “Close To You”. As I was humming this tune innocently, the twist in the lyrics just came to me and I could not help penning it down as a posting; just please forgive the corny change in the original lyric which still manages to somehow rhyme ! For those who are curious, the original lyric is “Why do birds suddenly appear, every time you are near”.
The title actually refers to my observation that stock markets in general tend to rebound sharply and suddenly after a prolonged period of fear, trepidation and uncertainty. After some thought and some additional reading from investment and market psychology books, I have come to realize that this effect is actually rooted in expectancy and anticipation. Both are contributory factors which determine the tenor of the market and whether there is irrational exuberance or misplaced fear. I shall touch on the former first, move on to the latter then attempt to gel the two together to make a coherent argument as to why the mixture of the two has such a dramatic impact on the stock market.
Expectancy refers to expectations of certain events and their likelihood of occurrence will determine the magnitude of the psychological reaction. A good example would be expectations of a 50% jump in profits for Company A, based on Company A’s track record of good growth and also prudent and steady Management. Expectations would be high for the Company to grow its profits by more than the long-term average of 10-20% due to external factors as well, such as a booming economy, favourable economic policies or strong interest in that industry.
This is an example of expectations being pushed high as a result of a myriad of factors. The result is that if the Company reports a 30-35% increase in earnings, the result is a drastic sell-down in the Company’s shares as expectations were not met. This is also known as the “expectation gap”. The magnitude of a psychological reaction to an expectation gap depends on the strength of belief in the outcome, as well as the depth of difference between the perceived outcome and the actual result. The converse is also true for expectations of poor performance, but the reader should note that the resultant positive reaction is largely more muted than one composed of negative surprise. This is due to the previously mentioned over-reaction bias inherent in all humans, who tend to over-accentuate the negative and discount the positive. Read more...
