Take a good dose of psychology courses. That is the suggestion for young budding security analysts, market strategists and portfolio managers. I know, it sounds like pedology class will make one a better chef. What does one have to do with the other? Why is this important?

To many, investing seems to be so logical. Revenue minus expenses equals profit. Multiply profit times a growth assumption and, voila, you have the fundamental value of a company. Buy the stock if it is trading below that value; sell if the stock is trading above the value. Simple, right? As Warren Buffet said, “Investing is simple, but it’s not easy.” ‘Simple’ in that the goal is to buy low and sell high, but ‘not easy’ as the market is in a constant state of flux.

Much of that flux, at least in the near-term, is based on individuals’ buy/sell decisions. Decisions, by their nature, require human brain power, which is entwined with how the brain works, aka. psychology. In fact, the study of psychology upon the investing world has gained momentum over the years into its own brand of course work known as Behavioral Finance. Understanding how our brains work will help guard against your own demons as well as recognize the market’s illogical happenings.

Currently, there seems to be at least a couple psychological forces influencing the markets. The first is Recency Bias. Recency Bias is the notion that people overemphasize on recent events. Recency Bias may lead investors to think that the current stock market downturn will extend indefinitely. Recency Bias can lead clients to make short-term decisions that deviate from their financial plans. The best way to defend against Recency Bias is to 1) realize Recency Bias exists, 2) focus on your long-term plan, and 3) resist the urge to make knee jerk reactions, even if you feel they are informed knee jerk reactions.

A second current psychological factor is herding. This one is so fundamental it goes back to early humans. Being herd animals, we relied on individuals in a group to inform the whole group, even non-verbally. Spotting a tiger in the distance might have been enough for one person to run, prompting everyone else to do the same without having to re-evaluate the situation. Those ancestors that did not, were rewarded with the cessation of their genetic line.

Today, most of us do not have to worry about a pouncing tiger, yet the herding mentality is still within us. When large market declines happen, many start running without stopping to think, “what are we running from?” The downdraft can be exasperated, becoming a self-fulfilling prophecy. The best way to defend against this is to 1) recognize herding exists, 2) focus on your long-term plan, 3) resist the urge to make knee jerk reactions, even if you feel they are informed knee jerk reactions.

I hope you notice the theme as the prescriptions are the same. First, recognize we are human and subject to human psychology. No one in infallible. Second, remain focused on what is important. Your portfolio was designed with volatility in mind. Lastly, the current situation will not last forever. Who knows, maybe understanding soil composition (pedology) may help chefs cook with better ingredients.