This is part three of a series on bull markets, specifically on investing when the markets are up. Click here for part one. Click here for part two.
Investor psychology plays a major role in whatever the market is doing every day. If the market is up, it’s because investors are optimistic about the future, while a down market is an indicator that most investors are worried about something. Let’s look more deeply at the role psychology plays in bull markets and examine techniques for making money wisely at a time when it might seem like you can’t lose no matter what decision you make.
Bull market psychology
When the bulls are running on Wall Street, the overarching emotion is soaring optimism. Investors see nowhere else for the market to go but up, and so assets are off to the races, carried along by investor enthusiasm. Economic indicators are all positive, and appetite for risk is healthy as a result. The nation’s gross domestic product is growing steadily, unemployment is low, and corporate earnings are up. Consumer sentiment is also high because consumers are not worried about potentially losing their jobs or not having enough money to pay the bills. They’re also spending more money because they feel like they have plenty of it, and as a result, corporate earnings are high because more money is going into the pockets of businesses. It just looks like green pastures all around.
As investors see nothing but blue skies ahead, so they become much more open with their money. Instead of being afraid of being in the market like they do during a bear market, investors are afraid of missing out on gains. In the early stages of a bull market, trades are made based on fundamentals like earnings numbers as the recovery from the bear market takes hold. Instead of staying out of the market, investors are getting back in and basing decisions wisely on fundamentals.
However, the longer a bull market goes on, the more secure investors start to feel in it. Thus, in the mid to late stages of the bull market, investors start thinking less and less about fundamentals and begin to invest more with their emotions. The mindset that it’s impossible to lose starts to take over, and the valuations of some companies soar much higher than they have any right to climb. Valuations become divorced from fundamentals, and trading multiples become ridiculously high. Stock prices climb as demand outstrips supply.
Because investors see nowhere for the market to go but up, they tend to pour more capital into riskier investments like stocks and pull capital away from “safe haven” investments like gold. Gold prices decline because of this increased appetite for riskier assets because they’re not worried about simply storing value. Instead, the driving mentality is one of growth and greed. The more money they rake in on their investments, the more money they want. And since the bulls are running and the markets are up, most investors see their ability to make more money as being endless.
How to invest in a bull market
Perhaps the biggest problem with investing in a bull market is the fact that any correction or downturn takes investors completely by surprise, especially when the bulls have been in control for an extended period. It might seem impossible to lose money in a bull market, but it’s just as important to make wise decisions when the market is up as it is when the market is down. Of course, it can be easier to make money in a bull market because more assets are moving up than down. However, it’s also easy to lose a lot of money by buying while things are high instead of waiting to buy until prices fall.
Since the market is constantly running from one extreme to the other, it’s best to dig into the market while prices are down during a bear market or correction. Then when the bull market hits, you can sell and turn a profit because you bought stocks while the price was low and waited to sell until valuations soared to obscene levels. The best way to do this is to keep a long-term mindset of the market, although talented day traders can find ways to profit even with a short-term view of the markets.
A buy-and-hold strategy involves buying stocks and holding on to them, hopefully while the value is increasing. Then when you think the price is close to a top or if it has moved beyond where you are comfortable holding it, you can sell and rack up a profit. You may also want to consider adding to your position as the price increases with a plan in place to sell most or all of the position when the price reaches a certain level.
Since the ultimate goal in investing is to buy low and sell high, it’s always important to watch for retracements, corrections or pullbacks even when the markets are up. Even in a blue-sky mindset, prices won’t be increasing 100% of the time. Prices will fall into a correction or, at the very least, they will retrace some of their upward move. In the later stages of a bull market, it can become more difficult to make a profit, especially if you’re starting to wonder just how much higher prices can really go. However, by watching for retracements, you can pick up a position or add to an existing position when the price falls, hopefully just before it rises again.
Passive and active investing
One of the easiest ways to invest in a bull market is in a passive index-tracking fund. These funds track a major index like the S&P 500. As the S&P increases in value, so the fund that tracks it does as well. Passive funds are great choices during a bull market because most stocks will be climbing steadily. One of the benefits of a passive fund is the lower fees involved in investing in them. You aren’t paying a fund manager to pick stocks for you because the fund tracks the selected index. Since the market is in a general uptrend, it’s harder to lose money, especially on blue chips like those found in major indices. Being able to turn a profit while also paying less in fees is a major advantage of passive funds.
On the other hand, some investors aren’t happy with the steady gains they can enjoy from passive funds. Instead, they prefer to have a fund manager actively picking stocks for them. These active funds come with higher fees, but if you choose the fund manager wisely, you could see better returns on them than you would on a passive fund. The whole point of taking an active investing position is outperforming indices enough that your net returns are higher after paying the increased fees involved in actively-managed funds.