What drives a market? What makes it go up? What makes it go down? From a fundamental perspective, it’s the result of buying and selling in large quantities. It’s the actions taken by the large institutional investors that move the market. But their actions are nothing more than the culmination of millions of people acting in their own self-interest. What truly moves the market is mass psychology.

The market goes up when the psychology is optimistic and it goes down when the psychology is pessimistic. It sounds simple enough, and at times it is, but everything gets muddled when investors give in to the emotions of fear and greed. There are stages in the market cycle that are dominated by these emotions, and there are stages in the market cycle that give way to rational and efficient pricing. If we understand mass psychology, we can learn to interpret these cycles, and then develop an understanding of herd mentality. This enables us to determine when it’s best to move in unison with the herd and when we should move against the herd.

Understanding psychology is equally as important as determining which stocks to buy. Understanding our own psychologies helps us enter into positions that adhere to our inherent way of thinking. To give an example, we always want the risk of our investments to align with our psychological tolerance for risk. If we go into a risky investment without maintaining a strong psychology, the decision process becomes clouded. Emotions take over and failure becomes inevitable. We’ll sell when we should see things through. We’ll average down and buy more of a stock that has no hope of ever coming back, all because we haven’t mastered the psychology of taking a loss. We’ll make horrible attempts to recoup that loss as quickly as possible when the rational thing to do is recoup the loss in accordance to the market’s timeframe.

A young investor should implement strategies that differ from those of an experienced investor. A wealthy investor should implement strategies that differ from those of an investor striving to become wealthy. Different investors maintain different psychologies, and the investor who understands these psychologies can position herself for greater success.

The successful investor will first take time to understand their own inherent psychology, and then take time to understand the psychology of predominantly successful investors. Wealthy investors are more likely to back their positions with a strong psychology. It’s not that wealth enables them to build a strong psychology, but that it enables them to only invest when the odds are stacked in their favor. From there, the psychology flows naturally like water off windows. We can learn from their psychology because we also want to invest when the odds are stacked in our favor, but there will be times when we need to be more aggressive in order to create wealth. This requires the ability to develop a different psychology. We start with our own inherent psychology, adopt what we can from the psychologies of successful investors, and then progressively tweak our psychological perspective as the game changes. The market will move to new stages in the secular cycle, and the size of our investments will (hopefully) increase. It’s important that our psychology changes along the way.

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