The following chart tells a timeless tale of investor psychology:
As equity prices trend higher investors are willing to take more risk, however, at the first sign of a market downturn investors are quick to liquidate positions and exit their market exposure. This phenomenon essentially boils down to a dynamic in which investors take the most risk when absolute risk is the highest (prices are the highest) and take the least risk when absolute risk is the lowest (prices are the lowest); this is the investor’s folly, succumbing to recency bias or the bandwagon effect.
The following quote from legendary investor Howard Marks comes to mind:
“When things are going well and prices are high, investors rush to buy, forgetting all prudence. Then when there is chaos all around and assets are on the bargain counter, they lose all willingness to bear risk and rush to sell. And it will ever be so.”
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