Investing is far from an exact science and in many ways it can be considered an art.  Nobody has the perfect process or equation to tell them when to buy or sell, even though many will try to convince you otherwise.  Just walk through a bookstore.  You will see the shelves lined with investing books titled, “How to Beat the Market” and “Get Rich Quick!”  Although most of these books provide good insight, not one has all the answers.

While the golden rule in investing is to buy low and sell high, it is never that simple.  Unlike the field of engineering or architecture, there are not many absolutes in the investing world.  Most successful traders throughout history would tell you that they became great traders only after experiencing losses along the way.  Investing is a process of learning from your mistakes and growing from what you have learned over time.

Human psychology and its effects can have a significant impact on the markets.  Movements in the market are not always rational because the world we live in is not always rational.  Most buy and sell decisions are driven by four very powerful emotions:  fear, greed, panic and euphoria.  The graph below charts those emotions in the context of the market:

During the “Dot Com” bubble in the late 1990’s, Alan Greenspan famously coined the term “irrational exuberance”.  Investopedia defines irrational exuberance as, “Unsustainable investor enthusiasm that drives asset prices up to levels that aren’t supported by fundamentals”.  Although this was the first time the term was used, the idea is nothing new in market history.

One of the most interesting examples of irrational exuberance dates back to 1637, in the height of “Tulip Mania”.  It was a time when the Dutch port of Amsterdam became one of the richest cities in Western Europe due to international trade.  The wealth fueled a cultural change, whereby people coveted various new luxuries – one of which was the tulip.  The trade of tulips was facilitated by an advanced trading system similar to the options and futures market.  Traders were able to buy and sell tulips of all different shapes, colors and sizes.  As more and more people sought out tulips,  “tulip mania” began.  The amount of money people were making was incredible.  This perpetuated a crowding effect into the tulip market.  As the story goes, eventually a single tulip was priced equivalent to THE ANNUAL SALARY OF A SKILLED HANDYMAN and so the first ever financial bubble was born.  The bubble eventually popped, like all bubbles do and the prices dropped to a hundredth of what they were at the top of the market.

Although this is an extreme example of a market bubble, everyday buy and sell decisions are driven by the same human emotions.  There have been many bubbles throughout history to varying degrees and there will continue to be bubbles as long as there is human input.  The lesson to learn from this as an investor is to not let your emotions drive investment decisions and don’t fall victim to fear, greed, hope and regret.  Instead, apply a rational investment strategy and continue to build and improve on your strategy.