Is this the beginning of a crash?

It certainly could be, but the odds do not favor it. Statistically speaking, it is far more likely that a run-of-the-mill correction is now underway and working its way through each sector of the market, to varying degrees of severity. Counter-trend rallies are sharp and short (think Wednesday), which is fairly characteristic of a defined downtrend. The 200-day moving average is rising up just beneath us and it may offer some solid support, just as it had in December of 2012.

But you’ll be forgiven for panicking. As human beings, we all suffer from the same cognitive biases more or less. Being aware of that fact may help a little. Here’s Cass Sunstein writing at Bloomberg View talking about how 2011 felt like another 2008 for him, thanks to three key biases :

Availability bias isn’t exactly irrational, but it can produce big mistakes. The stock market did collapse in 2008, but it doesn’t collapse very often, and in 2011 I shouldn’t have focused on the risk of another meltdown.

The second mistake involves “loss aversion.” People tend to hate losses from the status quo – in fact, they hate them far more than they like equivalent gains. If you suddenly lose $10,000, the distress you would feel would almost certainly be greater than the joy you would feel if you suddenly gained $10,000.

The irony is that if we make our decisions on the basis of loss aversion, we’ll end up as big losers. A case in point: As the stock market started to fall, I wanted to prevent losses, and as a result, I lost a lot.

The third bias is called “probability neglect.” Human beings tend to focus on worst-case scenarios, especially when their emotions are running high, and not on the likelihood that such scenarios will actually come about.

You know my number one rule for market corrections: ABC – always be cool. 

Not every sell-off is 1929 or 2008. There’ve been 27 corrections since World War II for US stocks in which the market sold off between 10 and 20%. There’ve been only 11 instances in which stocks dropped by more than 35 percent. That’s almost a three-to-one probability that this doesn’t snowball into catastrophe.

Do your best to ignore the most hyperbolic commentary this weekend. The “Ministers Without Portfolio” – bloggers, newsletter assholes, etc – will be out in force with their prognostications. Most of them are secretly in passive index funds with their own money and only make their bold calls in the public eye to earn a living. They do not manage money because if they did, they’d never make anyone a dime. Their hysteria will not be helpful, even if this is one of the rare occasions when the broken clock is accidentally right.

Lastly, if your portfolio feels like its bleeding you to death, you’re probably more concentrated than you think.

Source:

Why Do Investors Make Bad Choices (BloombergView)

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