The Fear Factor

Beyond The Numbers: The Emotional Side of the Financial Markets

Welcome to “Beyond The Numbers”- a monthly newsletter that aims to explore the human side of finance.

We know that the financial world can be daunting and overwhelming, and that numbers can only tell part of the story. That’s why we’re here to dig deeper and uncover the emotions, feelings, and psychology behind the markets.

The decisions we make about money are often influenced by our emotions and biases. Understanding these factors can help us become better investors, spenders, and savers!

My name is Sadaf Poursheikhani. I was born and raised in Iran, sauntered through the hallowed halls of academia, weaving between psychology and economics until I stumbled upon the enchanting world of behavioral economics, a love affair I've ardently pursued ever since. My academic journey reached its peak in a whimsical exploration of the psychology of the stock market during four lockdowns in Germany back in 2021-2022. Now, I find myself immersed in the world of Asset Management, but my fervor for dissecting the quirks of investor psychology remains undiminished. Join me on this delightful journey as we uncover the secrets hidden within the financial labyrinth.

In this Newsletter, I plan to bring thought-provoking analysis about the emotional side of finance. I’ll explore topics such as fear, greed, hope, and anxiety, and how they impact our financial decisions.

Whether you’re a seasoned investor, a novice trader, a rookie in asset management, or a stay-at-home mom, who’s a financial enthusiast, my goal is to provide you with a fresh and easy-to-understand perspective on the emotional side of the financial markets and help you navigate the complex world of finance with greater awareness and understanding. I hope you’ll join me on this journey of exploration and discovery!

First stop:

The Fear Factor: How Emotions Influence Investment Decisions?

When it comes to investing, emotions can be like a rollercoaster ride. Fear can make investors want to jump on the ride, but it can also cause them to hit the panic button and jump off at the wrong time. That's why it's important to recognize the role emotions play in investment decisions and develop strategies to manage them.?After all, making wise investment choices is about being level-headed, not chicken-hearted!

One of the most important effects that fear can have on the market is called:?“the self-fulfilling prophecy”. It's important to note that this concept, as described below, is oversimplified and may not fully capture the complexities of financial markets and psychology:

Self-fulfilling prophecy occurs when an original false social belief leads people to act in ways that objectively confirm that belief.

Translation?

When someone wants to achieve something, one clever way of doing it is to create a fake problem and scare people with it. Then, they can present themselves as the solution to the problem that never existed in the first place!

I remember whenever my grandmother didn’t want us to go through her cabinet looking for chocolate and candy, she would scare us of a thing called ?Looloo“: ?Looloo will punish bad children. Looloo will come to your dreams and will take your peaceful sleep away from you. “

And then ?Looloo,“ even if imaginary,?would?come to my dreams and?would?scare me and?would?stop me from trying to reach that cabinet. And I would crawl into my grandmother’s bed, where I could feel safe and protected by her.

I’ll walk you through another example to make my point even clearer:

When central banks aim to lower the exchange rate, it's a bit like they're performing a delicate dance with the financial markets. They use their tools and policies to influence currency values, much like a conductor guiding an orchestra. Instead of shouting, “The sky is falling!”, they employ strategies such as adjusting interest rates and intervening in foreign exchange markets, often guided by principles like the “Taylor Rule”. And voilà, the exchange rate often responds as desired.

Now let us take a trip down memory lane and delve into history:

In August 1985, the tragic incident involving British Airtours Flight left 55 people dead due to a fire on board and toxic smoke inhalation, with the chaos during the evacuation, primarily caused by stampeding, exacerbating the situation.

Similarly, the global financial crisis of 2008 had far-reaching consequences, with subprime mortgages playing a significant role in its origin. These risky mortgages, representing less than 1% of the world's total debt, were a critical factor that contributed to the crisis. However, it's important to note that the crisis was a complex event influenced by various factors, including the widespread panic and risk aversion that worsened the impact of the mortgage-backed market crash. This multifaceted crisis involved housing market bubbles, complex financial instruments, regulatory issues, and the interconnectedness of financial institutions.

The moral of these stories, you ask?

If people hadn't all woken up at the same time and realized they were duped by the bank's empty promises, the financial world might be in a much better place today. But instead, we got a crisis that made the Titanic look like a pool party!

I'm not suggesting that banks and rating agencies could have and should have continued their practices indefinitely, but at least a gradual change for the better could’ve been a possibility. Similarly, if passengers on the British Airtours Flight had never noticed the engine fire, far fewer people would have lost their lives.

Fear is like an appendix - it's an unwanted invisible organ from our evolutionary past. It's related to pain and helps us spot real dangers.?Without fear, we’d be in big trouble- just think of a world without anxiety-ridden fire drills or horror movies!

As one of my favorite psychologists, Jordan Peterson puts it: “Picture a starving rat chasing some food. Now add a cat following the rat to the equation - that rat is going to pull even harder towards that food!”

Getting away and moving forward are two separate motivational systems, but if you combine them, it's gonna be something man! As potent as it gets: Maximal Motivation. Something like a motivational cocktail with fear as the secret ingredient. That's why it is also necessary when our anxiety chases us towards our goals.

The motivational power of fear can also be harnessed when making wise financial decisions. Just like in the rat example, fear can act as a powerful motivator for individuals to take steps to protect themselves against potential financial risks. By acknowledging the possibility of financial loss and preparing for it, we could use our fear as a driving force to make smarter financial decisions. This may include creating a financial plan, diversifying investments, and being cautious when taking on debt. Instead of letting fear inhibit us, we can use it as a tool to become more financially savvy and secure our financial future.

Note of the month: Put a scary movie on mute, and it will not be that scary anymore. The background music in that movie is our fear. Yes, we can hear it, but we don’t have to listen to it.?

?

Disclaimer:?I would like to remind readers that this newsletter is based on scientific studies, my own research, and personal opinions. It does not reflect the views of any organization, and I am not providing financial advice. Rather, the aim is to shed light on the emotional side of the market and provide insights into how emotions can impact financial decision-making.