Fear of Losses
In the long run, markets are driven by fundamentals. In the short run, markets are driven by fear and greed.
The mere mention of emotion conjures up an image of an amateur. But, more often than not, it’s the professionals succumbing to fear. The fear of losing money, of losing clients, and of losing their jobs.
The professionals job is to try to outperform, but at the very least, to not lose clients. The job becomes “don’t make any huge bets that could make you underperform substantially.” This incentive and the emotionally baggage associated with thought of losing ones job for substantial underperformance leads to emotional decision making.
For example, in Fortune’s Investor’s Guide 2008, the experts wear their fear on their sleeve. One expert, Susan Byrne, is quoted saying, “Think in terms of being willing to lose opportunity instead of capital. Losing opportunity can be embarrassing, but losing capital is permanent.”
But, as any Economics 101 student will tell you, losses are losses whether they are due to a decline in market value or due to foregone profit. The only thing that rationally matters is what expected return for what risk. Trying to limit losses after the bubble has popped is more an emotional response than an analytical response. The professionals limiting their risk today are just compounding their mistake. It goes without saying, that when emotions drive decisions, the wrong decisions are often made.
