Market analysis: Playing the ball, not the man

Market analysis is often presented as an exercise in objectivity. There are earnings to assess, valuations to compare, risks to price and future performance to consider. The difficulty is that, other than earnings, every number is subjective. Investors must decide what matters, what doesn’t and which risks deserve more consideration than others.

That makes psychology rather harder to separate from analysis than we might like. Before examining the market, it is worth examining the person doing the examining.

Most of us are better at identifying other people’s biases than our own. The evidence suggests that investors are no exception. A 2025 review covering 63 empirical studies found repeated evidence of overconfidence, herding, loss aversion and other behavioral influences on investment decisions. These effects are not confined to inexperienced investors making poor decisions on social media.

Experience and expertise do not switch off the basic human tendency to favor evidence that fits an existing view, dislike losses more than equivalent gains and take reassurance from the behavior of others.

Sound investment psychology is not about becoming the mythical unbiased investor, afterall investment is all about weighing the odds. It is about understanding where your judgement is most vulnerable. Playing the ball, not the man, becomes considerably easier once you accept that you are one of the players.

A private bias is one thing. A bias shared by enough market participants is quite another. Markets trade on perceptions of the future. Investors buy what they expect other investors will eventually value more highly and sell what they believe will fall from favor. When the same assumptions become widely held, those assumptions can move prices in their own right. That is how investor psychology can become market psychology.

Optimism attracts capital, rising prices appear to validate the optimism and the original thesis becomes harder to question. The process works just as efficiently in reverse. None of this tells us where fundamental value lies.

In a world of casino capitalism, doing nothing can be remarkably difficult. Almost every incentive points the other way: more trading, more turnover, more reaction to the latest piece of data or change in sentiment. Activity is visible, but patience is not.

That has implications beyond the returns of individual portfolios. When market participants increasingly have similar transaction needs, risk assessments and investment horizons, liquidity can become more fragile. An unexpected flow then has a greater chance of exceeding the risk-absorption capacity of market-makers, producing price moves that say as much about positioning and liquidity as they do about underlying value.

Meanwhile, sticky, patient, fundamental capital now represents less than 10% of total equity market turnover.

That leaves relatively little capital willing to look through short-term noise and wait for a thesis to play out. Yet long-term investment decisions often require exactly that.

Sometimes the useful edge is not seeing something everybody else has missed. It is having the discipline not to respond to everything everybody else can see.

Ken Griffin estimates the hedge fund industry's cost of capital at the risk-free rate plus 4%. Returns above that hurdle attract money, but successful strategies do not remain untouched by their own success. Capital flows in, trades become crowded and alpha is gradually diluted.

At the same time, Griffin argues that “the here and now” is becoming much easier to understand as talented people work alongside increasingly capable AI.

That potentially changes where investment advantage lies.

When everybody can process today's information more efficiently, judgement about the long term becomes relatively more valuable. The investor still has to decide which changes are temporary, which are structural and what those changes imply for valuations several years from now.

AI itself illustrates the problem. As I discuss in When will the AI bubble burst?, recognizing the importance of a technology is not the same thing as knowing what today's assets exposed to it are worth.

Machines may well be good at processing information. What they cannot do is relieve investors of the responsibility to form a view.

You cannot remove psychology from investment decisions. You can, however, challenge your assumptions.

James Aitken reads the investment books and research you don’t have time to, combining that work with more than 30 years of market experience to offer an independent view of what matters – and what does not.

Read his investment insights, including a recently released post on the Fed’s forward guidance, adapted from research previously shared privately with clients.