There are many different reasons why people choose to invest in equities, however it becomes a lot more difficult to pick the right equities and avoid the wrong ones. In many cases, investors find themselves buying into companies that are highly valued and selling them weeks, months, or even years later once their value has all but disappeared. This is what is known as the cycle of investor emotions which, not surprisingly, are parallel to the market cycle.

There are four (some argue five) documented emotions when it comes to the market cycle.

1. Trough - At this stage, the market has reached its bottom. Most recently, that would have been March 9, 2009. Emotionally, however, jumping into the market is difficult because the market has dropped so much that equities are out of favor and other asset classes (like high yield bonds and gold, most recently) became the flavor of the day. Overall, people are demoralized and discouraged about equities and often opt to “cut their losses” at this stage before it gets any worse.

2. Recovery - At this stage, the market is starting to turn around. There is still negative economic data, yet more and more companies are reporting better financial results. Still, investors are doubtful and stay away in fear of a “double-dip” or their other investments are still performing quite well.

3. Market Expansion - Here, the economy is humming along, companies are reporting record profits and tremendous financial strength. Investors are more willing to invest because of the hope such numbers tend to offer, but are sometimes reluctant to get into equities because they want to get in on a pullback. These pullbacks may or may not happen.

4. Market Peak - Here, the markets are at their most expensive and the bulk of the gains would have been priced into equity prices by now. However, worried that they have already missed too much, investors will often jump in at this stage - very little is underperforming by now anyway. There are little, if any, signs that the economic expansion will end, rates are high and the general sentiment is euphoric.

And then of course, the market turns around, beginning the stage of denial that keeps people invested in equities that they should actually dump. They will wait until the trough before offloading and switching into another asset class which, by then, is not only unwise, but too late.

These investor emotions are quite real. After all, unlike professional investment managers who play with other people’s money, individual investors can associate overtime, sacrifice, blood and tears with their hard-earned investments, making themselves that much more sensitive to pain associated with losses.

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Chris has more than 17 years of financial services experience. He is currently the Fund Advisor at the Mutual Fund Site.