This point was brought up by a reader, Mat Cendana yesterday. To address his comment, I like to share the idea from an article written by someone called ShibaShake in Hubpages (go here). Shibashake explained that our poor performance in the stock market is the result of our lack of understanding of Stock Market Psychology. His idea may not be original as he made reference to a book written by Robert Cialdini. Shibashake's article is very good and I would recommend that you read it. I have summarized the gist of his and/or Cialdini's idea for your easy reading.
If we see others getting rich by buying stocks, then it must be a good time to buy. The same goes when everyone else is selling because we would assume that bad times are just ahead. This is also known as the Herd Mentality!! Because of this, we will be buying when demand & share prices are high and selling when demand & share prices are low.
2. Stock Market Psychology - Scarcity
We all have a natural tendency of wanting things that are in short supply. The rarer an item is, the greater is its value because few will be able to possess it.
Similarly, we will rush in and buy stocks at $10 because we are afraid that in a short time they will only be available for $12, $15, or much more. We must buy it now, because the stock may not be available at this price for much longer. That’s why when the stock market is rising, we feel a great need to jump in and buy.
According to Cialdini, there are two other factors that would exacerbate the effect of scarcity. They are loss and competition.
1. Scarcity and Loss
I think we have all experienced this before in other areas of our life. We appreciate something more after losing it. It may be our girlfriends, our freedom or our money.
We like making money, but we hate losing money even more. This makes us most likely to buy when prices are high, because we have lost nothing and have gained much (at least on paper). On the other hand, we are not likely to buy when prices are low because we are afraid that we may lose more.
2. Scarcity and Competition
The other aspect of scarcity has to do with competition. When we are in direct competition with others for a limited item, the power of scarcity would kick in. This is when we must absolutely have it; not because we need it, but because we must not lose it to others.
When prices are high, we are most compelled to buy because that is the time when there is most competition for a stock. We must get it now before someone else gets it and makes money that should be ours. When prices are low, we are compelled to sell because we do not want to lose the opportunity of getting rid of our crap to someone else.
Cialdini suggests two ways to counter scarcity. They are:
1. Think before you act.
When we feel ourselves getting caught up in the emotion of the stock market, we must stop ourselves from buying or selling anything. Decisions that are made in haste are usually decisions that we will regret later on.
2. Item utility remains unchanged
When we are swept up by the power of scarcity, Cialdini suggests that we remember this
The item we now want more than ever, has not fundamentally changed. The utility we derive from it also has not changed, just our need to possess it.The points made by Robert Cialdini reveal much about ourselves, and shows us where we are most vulnerable to external manipulation.