Vanguard Money Digest

January 31, 2020

Understanding Stock Market Psychology

Understanding Stock Market Psychology
Nigerian Stock Exchange

By Shola Oni

Bullish trend characterized transactions on The Nigerian Stock Exchange in January as evident in dramatic change in some of its performance indicators. For instance, a measure of aggregate corporate gain called All-share index has been rising steadily while market Capitalization, the total value of listed securities follows the same trend.

This is not magic. Every normal market responds to available information, internally or externally, positive or negative. Such information could be even rumour but once it is price-sensitive, it can impact share prices upward, downward or make it stagnant. This is called market psychology. The Federal Government’s recent policy on Open Market Operation (OMO) as announced by the Central Bank of Nigeria (CBN) justifies the concept of market psychology.

By the policy, the apex bank announced the exclusion of non-bank locals (individuals and corporate) from participation in OMO at both the primary and secondary markets. This, obviously, implies that only Deposit  Money Banks (DMBs) and Foreign Portfolio Investors can participate in this juicy financial instrument. This policy did not come from the blues.

It is understandable that the apex bank has been coming up with creative ways to ensure that Deposit Money Banks channel credit to the real sector, to reduce crowding-out of the private sector in the area of credit. This is a follow-up to CBN’s raising of minimum Loan to Deposit Ratio (LDR) for banks from 60 percent in September last year to 65 percent. It’s all about liquidity management.

With the new policy on OMO at the primary market, bond yields, ranging from 5-year to 30-year, significantly reduced. In a similar vein, there has been significant drop in fixed deposit rate to as low as 2.5 percent. Meanwhile, the equities market has been experiencing downward trends, at times, posting negative returns since 2018. It is therefore not surprising that the policy on OMO has beamed a searchlight on investment in equities as a preferred alternative to fixed deposit or bonds.

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Investment in securities is akin to the principle of international politics: There is no permanent enemy, no permanent friend but permanent interest. Depositors do not place money in the bank because they so much like the Managing Director. They are assured of safety of the fund and accrued interest. Investors do not purchase shares of quoted companies because of their love for the Chief Executive Officer. They anticipate robust Return On Equity (ROE).

There is inverse relationship between investment in the money market and capital market. If the return on investment in the money market is lower, investors switch to the capital market and vice versa. This explains the recent trend on The Exchange whereby bell-weather stocks are enjoying positive rally.

Who are the losers and winners? Irrespective of the tenor of bearish trend, a shareholder in a company remains a part owner as long as he has not sold his equity. But how many investors have such patience? It is true that unforeseen circumstances may force an investor to sell-off but some take such decision out of mere panic or herd instinct. These are the losers when the market bounces back. The winners are those who take advantage of stockbrokers’ advice on when to exit the market. Many investors are currently smiling to the bank. The stock market cannot be bearish or bullish forever. It operates in cycle. It is the medium and long term end of the financial market while money market is basically short term.

We should endeavour to understand market psychology. It is the sentiment of financial market as driven by investors at any period. This happens frequently. When investors lose confidence in the market, they embark on massive share dumping. Some market analysts believe that beyond fundamentals, market psychology is what drives markets upward and downward.

Investor psychology  can be validated by looking at the trading volume, including stocks that are frequently traded. Clients’ emotion such as fear, anger and even overexcitement can lead them a loss territory. This explains why the role of stockbroker is highly strategic. They understand the market mood, timing for entry and exit in a bit to ensure risk aversion. There must be risk at any point in time, but it can be managed through professional investment advice.

At one forum on Centre for Strategic Studies, it was agreed upon that “For those following investor sentiment and market psychology, the answer is simple: investors’ outlook on the market switches from optimistic to pessimistic. Positive fundamentals, such as rising corporate profits and lower unemployment levels, are not driving stock prices; investors’ perceptions are the market drivers.”

It is instructive to note that investors need to move closer to stockbrokers as they understand the strategy and tactics of market psychology.