Sunday, May 06, 2007

The problem with human psychology

One of the most difficult aspects of investing is conquering one's own psychology. What I mean when I say this is that as humans, emotions fill our lives and no one can truly say he invests without emotion. If you are capable of laughing, smiling, crying and feeling anger, then all this will also translate into emotional behaviour when you invest.

Trust me when I say that I've had my fair share of "mood swings" when I first started out investing in Dec 2004. From greed to fear to anger to disbelief to annoyance to denial, almost the entire gamut of emotions was felt by yours truly before I turned to value investing for an answer. Thus, don't blame yourself if you are new to investing and feel like it's an emotional roller-coaster ride. It's NORMAL ! What one can and must eventually do, though, is to master your emotions to the extent that they do not affect your rational decision-making process, in order to achieve success in investing.

I highly recommend "The 7 Deadly Sins of Investing" written by Maury Fertig of which I have purchased a copy. This covers the 7 sins of envy, vanity, lust, greed, anger, gluttony and sloth which affects all investors. You can find this book at any major book-store. I will now attempt to touch on some aspects of these emotional "sins" and to use my own experience to elaborate on them.

Greed - The most common emotion during a bull market. Greed can turn people into irrational "monsters" and it can really make one lose focus and direction. As Warren Buffett says so succinctly, all it takes is a lot of effortless money to make one lose all rationality. When I say this I mean buying on momentum (momentum investing), or getting easy money through contra trading. One must be cautioned that making money on contra during a bull market is a no-brainer, and this may make one get too carried away and he increasingly increases his bets as he buys on the way up. This will continue to a point when the counter itself is over-inflated, and it collapses in on its own weight much like a dying star collapses into a black hole. Don't treat the stock market as a casino, treat each purchase of a stock as if you were buying the entire business. Understand each business thoroughly before you commit to a purchase, and don't let greed blind you to an investment which may look sound but is priced expensively (as is mostly the case during a bull market).

Fear - On the flip side, fear is what causes people to "buy high, sell low". Fear is present only when people do not understand what they are doing, or when they do not know how to properly value a company. This occurs quite frequently for companies which go through RTO or reverse takeovers. They issue a gazillion amount of shares to the purchaser and in turn acquire a new business which becomes their new core business. In the process, existing shareholders undergo MASSIVE dilution and most of them end up clueless as to what the real value of the company is. Needless to say, panic selling usually occurs. This has happened to a few companies of late in the SGX, of which I will NOT name. Fear also causes people to irrationally dump shares in good companies because of weird and obscure factors like "oh BB selling", "oh funds are selling" or maybe "oh no my friends are selling !". Please remember that all these events do NOT change the underlying fundamentals of the business, so why should you as s shareholder be an eager beaver and dump your shares along with the crowd ? If you follow the crowd all the time, then you will be destined to share the same fate as the crowd most of the time.

Denial - This is one emotion which is seldom touched on. Denial occurs when people simply can't believe they made a wrong move, a bad trade or omitted to buy a good investment. I was in denial for quite some time when I failed to purchase Olam at $1.40, Pan-United Marine at $1.30 and Amtek at $0.55. Take it as a learning experience and evaluate why the mistake was made. The natural reaction is to feel angry and to admonish yourself for being "silly". The truly silly thing to do would be to buy the very same stock that you failed to buy just because its price was going up like crazy ! My advice: Stay cool, rationalize, compute the intrinsic value, assign a PER and obtain a fair value. If the market price is higher than fair value, let it go. Remember: A value investor should have infinite patience to wait for the right opportunity to come knocking. When that happens, he acts on it immediately and without hesitation.

Treat the market as a place for buying companies cheap and selling them when they become expensive. Mr. Market has mood swings and they should NOT affect you as an investor, as you yourself should be truly aware of your companies and how they function. The market is there to serve you, not to instruct you.

Good luck to all !


kleer said...

Hi musicwhiz,

Nice blog you have here, and I totally agree with your view that human phychology is a important deciding factor in the stock market. Once you understand that, and understand that the stock market will always be over exuberant or over pessimistic, the stock market becomes simpler to understand.

BTW, would you also care to exchange blog links? Leave a comment on my blog and we'll do the link up!

kleer said...

Cheers musicwhiz!