Here's why investor psychology is so important

YouTube

On Game Day, a young athlete can usually benefit by having a positive influence on the sidelines, be it a coach or a parent. I’ve seen this first-hand for many years.

When talking to a young athlete about a sub-par performance, a coach or parent can try and turn things around by yelling or demeaning. That usually doesn’t work.

On the other hand, the coach can stress the positives, and maybe past accomplishments, while addressing current missteps and a plan of action.

My daughter is now 21 and still plays fast-pitch softball in college. She definitely responds better to a positive message than a negative one. I know personally how this works since I coached (and watched others coach) her and her two brothers.

The markets, however, don’t care how they’re treated. Investors are always looking to buy or sell based on what they think will develop in the future. But there’s no doubt the markets respond to positive and negative messaging. Some call it market psychology, but it’s really investor psychology.

Instead of looking at current data like earnings, revenues or cash flows, investors act on projected sales and forecast earnings per share. So, a company’s CEO can talk up their own stock with a rosy forecast. However, since public companies are subject to regulation, many have halted forecasts altogether.

That’s where investment house research analysts come in. Most of the large firms have in-house analysts that scrutinize firms that they do business with or have some sort of relationship with (investment banking, institutional services, etc.).

Even without a banking relationship, some firms may analyze companies within a business sector and provide research to retail and institutional investment clients. In any case, these analysts can move a market by giving a positive or negative investment recommendation on a company.

Now we come to the kings of all market-movers – central bankers. From the former Chair of the Federal Reserve Bank, Ben Bernanke, to the current chair, Janet Yellen, any word that hints of monetary easing or tightening has the power to cause a run-up or a melt-down.

YouTube

When Bernanke first announced the tapering of QE back in May of 2013, asset prices dropped like a rock and U.S. Treasury bond yields spiked. This was known as the “taper tantrum” throughout the financial markets. And when he tried to clarify in June, the markets moved sharply again. Janet Yellen has been especially careful with her words so far.

The President of the European Central Bank, Mario Draghi, has moved asset prices with the best of them. His comment back in July of 2012 about “doing whatever it takes,” referring to the ECB’s version of quantitative easing, had a major impact on stock and bond prices around the world. Stocks shot higher and bond yields fell around the world, especially Europe.

The Bank of Japan (BoJ) certainly has to rank at the top of monetary interventionists. They have been fighting deflation by buying bonds (QE), tinkering with interest rate policy and anything that would prompt consumer spending, reflate real estate and other assets to generate inflation.

Of course, none of them worked. In fact, when BoJ governor Kuroda announced the latest experiment into negative interest rates, it failed miserably. About all it achieved was to make the yen stronger which hurts Japanese exporters.

Now, it looks like the BoJ, the ECB and the Fed are running out of measures to stimulate their economies. So when the investing public loses confidence – as is clearly already happening in Japan – their words will fall on deaf ears.

For the most part, central bankers know that easing investor psychology into a change with their wording, rather than shocking the system with a surprise action, can dull the reaction a bit.

But it almost doesn’t matter. Either way, investors are trying to get ahead of the curve and position for opportunity or avoid losses. Many times those reactions are overdone, but that’s just investor psychology.

The chart below shows what happened in long-term Treasury bond yields when Ben Bernanke explained that the Fed would be tapering their bond buying or quantitative easing in May of 2013 and then tried to clarify timing and ending of QE in June of 2013:

YouTube

When the Fed actually ended their bond purchases in December of 2014, yields had already long since peaked. They peaked nearly a year before the Fed ended QE. By then, investors had turned their focus on how asset prices would react to a weakening economy.

Of course, central bank talk and actions move markets outside of Treasury bonds. Stock prices, currency exchange rates, commodity prices and sovereign bond prices around the world are impacted as well.

But we focus on Treasury bonds in Treasury Profits Accelerator. By identifying the long and short-term trends in yields, we’ve developed a simple, consistent trading strategy that works. And it all comes down to investor psychology.

NOW WATCH: A Navy SEAL explains why he’ll never go skydiving as a civilian again