Irrationality and Investing

Irrationality and Investing

Investing in the financial market, if you’re level-headed about it, can make you a lot of money

Financial assets can be a great way for investors to generate wealth. In a capitalist economy like ours in Hong Kong, we always hear tales of people who have struck it lucky by working the financial system.Technological advances have made it easier for people like you and me to follow in their footsteps too, even if we have little or no experience at it. Unfortunately, this mysterious world of statistics, psychology and finance is also an irrational world, so is there even any point in us trying to participate in it?

Emotions play a huge key role in the financial market, making investing a risky business. It’s been said that, in the short-run, the stock market is a “voting machine” that people respond to, with reason and sentiment. People can behave very recklessly when money is involved – and this was certainly the case for Sir Isaac Newton, the famous English physicist and mathematician.

In 1720, investors were speculating wildly on stocks in the South Sea Company. Newton decided to invest too, and ended up profiting. Buoyed by his success, he continued to play the stock markets, but as Herbert Stein once said: “Anything that can’t go on forever will end.”


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The stock bubble burst and Newton lost £20,000 (which is HK$31 million in today’s money), proving that just because a person is intelligent does not mean they are immune to irrationality. Afterwards, Newton said that he “could calculate the motions of the heavenly bodies, but not the madness of people”.

Human behaviour causes markets to swing up and down wildly. During the 2008 subprime mortgage crisis, global financial instruments – monetary contracts between parties – experienced massive devaluations, becoming worthless. The Hang Seng Index dropped by 48 per cent, and investors and speculators lost huge sums of money as people began selling in their panic to recoup their losses.

For every major disaster though, there are those who emerge as winners. During a crises like the one in 2008, companies sell for very low prices. At the time, the MTR Corporation stock halved – but because the MTR-KCR merger had just closed, both the fare revenue and operating profits rose by 60 per cent. Prices fell so quickly that the whole company was selling for less than its net assets – although its net assets were HK$96.9 billion, its market value was HK$84 billion. If you bought shares in the MTR Corporation during this time, you would have seen your investment rise by nearly 90 per cent in less than a year. Not a bad way to accumulate capital, right?

“History doesn’t repeat itself, but it does rhyme,” said Mark Twain. Governed by human psychology and susceptible to irrationality, all financial markets inevitably experience significant turmoil at some point or another. But the truth is you can potentially make a lot of money from them, too.

I suppose the real question is this: when everyone else is selling, do you have the courage to start buying?

This article appeared in the Young Post print edition as
Irrationality and investing

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