A Look Into Bear Market Psychology: A Warren Buffett Approach
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” - Warren BuffettDespite some positive momentum, the cryptocurrency market is still suffering. The cryptocurrency bear market has caused continuous panic, fear, and uncertainty amongst investors; but awareness of common behavioral investment biases can help individuals navigate market turmoil and avoid making behavioral mistakes to the individual’s financial detriment.
Behavioral Finance is the study of the influence of psychology on the behavior of individuals, including investors and analysts, and it examines the neurological process of decision making pertaining to the ambiguity of financial issues. Behavioral finance also attempts to understand how the collective decisions of individuals affect the performance of the markets.
Embedded in the human DNA through evolution, is the behavior of making decisions quickly via heuristics and emotions, in a process known as Systems 1 Thinking. According to AthenaInvest, the individual typically makes 95% of decisions using a Systems 1 Thinking process, while the other 5% of decision making is fabricated via a Systems 2 Thinking process, which requires the conscious effort of logical thinking and analytical methods. However, by using the Systems 1 Thinking process and in making these decisions quickly, the individual often compromises the accuracy of those decisions. These inaccuracies in decision making arise in human behavior as biases.
The following is a list of common investment or financial biases displayed by the individual:
The Impact of Financial Biases
Many financial and investment biases are deeply ingrained in the individual’s subconscious mind and have, consequently, plagued a majority of individual investors, causing many investors to make decisions in a manner inconsistent with their best interests. A majority of investors exhibit these biases, including the ones mentioned above, and they are exhibited in the behavior of assets, sectors, and the overall market; the market reflects the sum of all biases and behaviors in gross. However, if the individual investor is able to identify these common biases and stray from conventional human behavior, he or she may be able to improve his or her investment strategy and success.
“Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ ... Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” — Warren BuffettBear Markets are the Greatest Behavioral Test
The lingering effects from the COVID-19 pandemic, high inflation, and other factors have caused a digital asset bear market; but, investors entering or in the midst of a bear market who have recognized prevailing financial biases may come out on top. In a bear market, when investors identify biases and keep mental biases and self-destructive behavior under control, the smart long-term decisions often may look foolish in the short term; however, these decisions, most often, are victorious, and Mr. Warren Buffett would agree.
“Look at market fluctuations as your friend rather than your enemy; profit from following rather than participating in it.”- Warren BuffettBuffett’s Approach to Bear Markets
Mr. Warren Buffett exemplifies the contrarian approach to investing during the bear market by relying on logic and historical market cycle data to realize gains. Mr. Buffett has predicted that bear markets may be followed by bull markets and record profits, based on historical data. His view on investing takes a long-term view and favors investors who take advantage of bear market discounts and investment opportunities. In a 1997 letter to his shareholders, Mr. Buffett said “So smile when you read a headline that says, “Investors lose as the market falls.” Edit it in your mind to “Disinvestors lose as market falls — but investors gain.”” Mr. Buffett’s advice is clear that it is essential to stay invested and not give in to the biases and fear factors that materialize during economic downturns; while short-term volatility and downturn may be distressing, investors must not diverge from long-term investment strategies and plans. Mr. Buffett puts forth the following strategies:
- Keep a long-term outlook
- Think independently
- Have self-confidence
- Accept if you don’t know something
- Have patience
“Price is what you pay. Value is what you get.”- Warren BuffettConclusion
Bear markets and economic downturns can be very intimidating, frightening, and alarming times for investors; but, it is essential for investors to consider the biases that emerge during these times and the opportunities that may be presented. Billionaire investor Warren Buffett is not deterred from investing during bear markets and focuses on the quality of the underlying business and long-term opportunities. Investors, by identifying common financial biases and following in Buffett’s footsteps can learn a lot from his strategy and approach to investing during economic turmoil.
“We don’t have to be smarter than the rest. We have to be more disciplined than the rest.” - Warren BuffettDisclosure
This research is for informational use only. This is not investment advice. Other than disclosures relating to Alpha Sigma Capital this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates, and forecasts contained herein are as of the date hereof and are subject to change without prior notification. We seek to update our research as appropriate.
Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. The price of crypto assets may rise or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments. We and our affiliates, officers, directors, and employees, excluding equity and credit analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives, if any, referred to in this research.
The information on which the analysis is based has been obtained from sources believed to be reliable such as, for example, the company’s financial statements filed with a regulator, company website, company white paper, pitchbook and any other sources. While Alpha Sigma Capital has obtained data, statistics and information from sources it believes to be reliable, Alpha Sigma Capital does not perform an audit or seek independent verification of any of the data, statis- tics, and information it receives.
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Crypto and/or digital currencies involve substantial risk, are speculative in nature and may not perform as expected. Many digital currency platforms are not subject to regulatory supervision, unlike regulated exchanges. Some platforms may commingle customer assets in shared accounts and provide inadequate custody, which may affect whether or how investors can withdraw their currency and/or subject them to money laundering. Digital currencies may be vulnerable to hacks and cyber fraud as well as significant volatility and price swings.
References:
https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/behavioral-finance/
https://seekingalpha.com/article/4486386-behavioral-finance
https://behaviouralinvestment.com/2022/05/24/what-we-should-remember-about-bear-markets/
https://finance.yahoo.com/news/warren-buffett-bear-market-advice-150100088.html
https://financhill.com/blog/investing/warren-buffett-bear-market-quotes
https://www.barchart.com/story/news/10867459/why-warren-buffett-buys-stocks-in-a-bear-market
https://www.fool.com/investing/2022/10/16/3-tips-warren-buffett-get-through-bear-market/
https://jwm.pm-research.com/content/23/2/70.short
https://www.financeandinvestingfacts.com/warren-buffetts-view-on-investor-behavior/
About the Author Jordana Cohen, Writer and Associate, Alpha Sigma Capital
Jordana Cohen graduated magna cum laude from Tulane University with a business major in finance and a minor in Spanish. She currently attends Law School at the University of Miami. Jordana is a published author of several technology macroeconomic reports (https://alphasigma.fund/what-you-need-to-know-about/). In her role as an associate at Alpha Sigma Capital, she works on contract review, investor relations, and macro research. She is also an active volunteer and foster coordinator of a dog rescue and shelter in Miami, FL.
