Of Men and Mania

To study the inexplicable tendency of human beings to swing between euphoric to depressive bands of emotions is the realm of psychologist but investors will do well to analyze this behavior of mob of which they themselves make a part or at least are affected by it.

The meteoric rise and subsequent fall of tech stock is nothing but history repeating itself.Times change,people change,places change but throughout we can clearly see a link between man and
manias.This link may have its reasons in the way of working of our mind, in the deep recess
where emotions and thought are formed. Further exploration of which is out of scope of this article.However I would like to give here some glimpses of past so that we can learn from them.For those, who don't learn from history , are condemned to repeat it.

In the world of finance manias make rule rather than exceptions.The tulip mania of 17th century , when prices of a simple humble flower shot up through the roofs to the extent that a whole estate was not sufficient to purchase a small contingent of tulip.This flower became an object of obsession among the upper echelons of society ,not due to some miraculous powers or beauty, but just because it was difficult to get it.It was imported from far away countries and was
difficult to preserve.The prices kept rising and rising an along with it the appeal of tulip as status symbol.It was the costliest and consequently most sought after gift.Then the inevitable crash came.The tulip traders who had made millions in trading tulips became broke as tulip lost its
charm.To answer the query why the crash came,it would be sufficient to mention that as there was no reason for its rise, the crash needed no reasons. 

Then came the south sea bubble,the gold rush which are sufficient as a storyline of a 1000 page novel.To say in a line ,everyone who was capable,had some cash or land and had dreams(qualifies practically everybody rich and young) went in search of gold in the colonies of America and Africa.Its worthwhile to note that even if the expected amount of gold were found then also they were doomed as the price of gold would have crashed with increase in the

The last century had its own share of manias.The rise of rail road stocks in the beginning of last
century,that of auto stocks in 1920s ,of airline stocks in 1950s and the most recent,the rise of tech stocks in late 1990s. 

To give some examples from the home, the Harshed Mehta orchestrated boom, the rise of
Non Banking financial stocks in 1995 and the recent rise of software stocks are the manifestation of same tendency of human mind which makes them susceptible to maniacal behavior.

All such inexplicable movements in prices start due to some fundamental reasons. If the momentum is sustained for quite some time than that alone becomes reason for further rise. To explain this I would compare  greed and fear as accelerator and break for the price movement. When price moves upwards for quite some time the public starts getting news of people who have made themselves rich in a short period of time. The lost of opportunity pinches everybody. If the rally is sustained further than the fear of losing the chance to be a part of party overcomes the fear of loss. This is how the breaks start functioning as accelerator and the prices rise to astronomical proportions. However in real life a car without break can not go ahead indefinitely. 
A crash is due and it comes as surely as night after day. After the crash the panic grips the crowd and all of a sudden negative news start flowing from all sides. A crash of a fellow driver(read NASDAQ) forces up to check the speed and grope for breaks. The crash brings prices not only back to the intrinsic values but often brings them even lower.

The lesson we can learn from these are many.
1. If something rises well above its intrinsic price then there is no limit where it will end but that it will end is sure. However you can not go short if you see an stock quoting much above it's real value. If that price is not high enough, than even two times that price isn't.  

2. You can not buy something just after the crash when this return to their real prices as the momentum generally takes the prices to opposite extreme. Wait while sense returns to the sensex.

3. You can not time your entry and exit in such conditions as all forecasts are based on reason and this is by definition rare element at such times. That means even if you save yourself
from the irrationality of mob, to forecast on the basis of their rational behavior is foolish.

4. You can not afford to be overconfident about your abilities as everybody among the crowd is feeling in the same way. Like everybody thinks that he will be able to sell of quickly if a crash comes.

5. You can think of your actions as pretty reasonable but even the reason wears rosy colors in its eyes. All the public and media is euphoric at such times. The news, forecasts, analysis and even warnings wear same color at such times. And lastly you can not say that you will plan your
action when such a thing comes but it never tells you of its arrival till such day when you realize that you have brought Wipro at 9500, Zee at 2000 and have no option but to wait and curse your luck.

Reference: Charles Mackay's Extraordinary Popular Delusions and the Madness of Crowds John Kenneth Galbraith's The Great Crash, 1929 Charles Kindleberger's Manias, Panics, and Crashes

Posted: Dec 4, 2000


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