Tuesday, October 09, 2007

Enjoying the Mkts record run?
Don't get too comfortable. The market's Black Monday/Friday breakdowns is a reminder of how quickly investor sentiment can turn.

As major stock indexes hit all-time highs,it's worth looking back 7 years( circa.2000) to a far gloomier time,when investors were cruelly and suddenly reminded that the value of their investments can depend on something as unpredictable as a mood swing.

Every once in a while, fear, snowballs into panic, sweeps financial markets,— the stock market crash of May, 2006,is a prime example.

But for whatever reason, the mood on Dalal Street shifted suddenly, and everyone tried to sell stocks at once.

"Something just clicked," says Chris Lamoureux, finance professor at the University of Arizona."It would be like a whole crowded theater trying to get out of one exit door." not bcoz they didnt like the movie.!!

It's a fairly common phenomenon in financial markets. Every stock transaction needs a buyer or a seller. When news or a mood shift causes a shortage of either buyers or sellers in the market, stock prices can surge or plunge quickly. Most of the time, balance is quickly restored. Lower prices draw in new buyers looking for a bargain.

Sometimes,as in 2000,2006 and many crises, things get out of hand. What happens at these moments is a mystery that may be best explained by dynamics deep within human nature.

Behavioral finance expert Hersh Shefrin, a professor at Santa Clara University,says "investors believe they understand the world". In a crisis, "something dramatically different happens and we lose our confidence," Shefrin adds. "Panic is basically a loss of self-control. Fear takes over."

Why don't smart investors, seeing others panic and sell stocks, step in to buy them up at a bargain?
First, it's very hard, in the midst of a crisis, to tell whether markets are acting rationally or irrationally.

It's also tough to think rationally yourself. "It's hard to keep your emotions in check when your money is on the line," Shefrin says.

And, even if you're confident the panicked market is giving you a buying opportunity, you're likely to want to wait until it hits bottom. If a market is in free fall, buying stocks on the way down is likely to give you instant losses. Not only will buyers hold back. A falling market will bring many more sellers out of the wood,searching for water,sheep,or wat ever u think...

Leverage is one reason for panic selling: Many investors buy stocks on borrowed money, so they can't afford to lose as much without facing bankruptcy.

This is one explanation for the temporary, sharp drops in many financial markets in May 2007.
Losses on leveraged mortgage debt prompted many hedge funds to dump all sorts of assets to raise cash.

The solution to a panicked market,is slowing down the herd of frightened investors all running in the same direction to catch the bus.

New stock market rules are already in place to pause trading after big losses.Indian markets stops trading when Markets losses reach 10% in any trading session.

"If you give people enough time,they may/will figure out nothing fundamental is going on," University of Michigan's Pasquariello says.

financial panics seems to be part of our collective human nature to occasionally reassess a situation, panic, and then all act at once.

Many see the markets as a precarious balance between fear and greed. Or, alternatively,irrational exuberance and unwarranted pessimism. "All you need is a shift in mass that's just big enough to push you toward the tipping point," Shefrin says.

What should an individual investor do in the event of a financial crisis?
If you're really sure that something fundamental has changed and the economy is heading toward recession or even another depression,Laloo/Mayawati is gonna become the Prime Minister,it's probably in your interest to sell.

But most experts advise waiting and doing nothing.

"In volatile times, it is very likely that you [will be] the goat that other people are taking advantage of," University of Arizona's Lamoureux says. "It's often a very dangerous time to be trading."

Shefrin adds: "The chances of you doing the right thing are low." Don't think short-term, he says, and remind yourself of the long-term averages.

For example, in any given year, stock markets have a two in three chance of moving higher. Other than that, it's nearly impossible to predict the future.

So, another financial panic may be inevitable.There's probably nothing you can do about it anyway. Anything you do might make your situation worse.

So the best advice is to send flowers to your stressed-out stockbroker(if they r your aunt/uncles!!), stick with your long-term investment strategy, and sit back and watch the market's roller-coaster ride.

Excerpts Edited by me and with comments courtesy-BusinessWeek's Online.
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