When I was in college (1999-2003) I worked full time for a local stockbroker. He was a top producer and well known in the local area. During those years I witnessed an entire boom and bust cycle. In the office I was the person that answered any questions clients would have to save my boss the time, effort, and annoyance.
We had over 1,100 clients, and when the markets crashed I think I heard from all of them over a 6-month period of time. I witnessed sadness, anger, hopelessness, and despair. I would go to work, the markets would drop again, the phones would ring, I would get the sh!t kicked out of me, rinse-repeat. When I met with my old boss just last month he reminded me if I wasn’t there during that time period he would of quit. I was the first line of defense, a human punching bag.
This experience was probably the best education I would ever receive. First hand seeing how human emotion and the stock market are intertwined helped prepare me to be a better investor. What I witnessed during those couple of years saddened me, but I was also disgusted. It made me numb and since then I’ve always been able to distance my emotions from the markets.
“Individuals who cannot master their emotions are ill-suited to profit from the investment process.”—Benjamin Graham
The other unfortunate result of my experience above is I cannot stand holding investors hands while the market or a particular stock drops. I have no empathy. The market pulls back and a position is down 20-30% quickly and all of a sudden panic sets in and investors first inclination is to start questioning everything and anything and wanting their hands held. Even on our members forum you will rarely see me respond to investors posting out of emotion. I’m more apt to tell you to sell your entire position.
As an aside, just last week one of my positions was down 20%. A fund manager emailed me, “What is wrong with this stock, how low will it go?”
My response, “It’s going to zero, please sell!”
I know it may sound cold, but I don’t get paid to deal with other peoples emotions, just my own. Coincidentally, this is also why I could never manage other people’s money 🙂
It is very important to keep your emotions and the market separated. How many times have you painfully threw in the towel on a stock because it was dropping and the very next day it pops and moves back the other way. More than once right? That is because everyone else is feeling the same emotions you are and everyone is throwing in the towel right around the same time.
Or the opposite, investors are always attracted to stocks that are rising. You’ve been watching a stock go up for days, weeks, months. You knew you should have bought it when you first saw it. Finally you can’t take it anymore and you buy it. A couple weeks later you realize your purchase was basically the all time high on the stock as it starts to go lower.
It’s human nature when you lose money quickly you want to make it back twice as quick. You start looking at companies in industries you would never look at. You might even skip necessary due diligence steps or start relying on other people.
Believe it or not this can also happen after making a lot of money. You become over confident and invest in areas outside your area of expertise. In 2010, I was coming off two major winners. I was cocky and invested in a couple biotechs. You sort of have the mindset, “Well if I invest in it I’m sure it will be a fabulous investment!” A year and several hundred thousand dollars later, Mr. Market taught me a lesson.
“A man who wants to lead the orchestra must turn his back on the crowd.” —Max Lucado
Slow down, keep focused, and stick to your strategy. Don’t let market fluctuations or stock volatility unnerve you. Understand human emotions and irrationality and use it to your advantage. Invest in what you know and more importantly understand what you don’t know. Invest in great management not great products. A great management can turn absolutely nothing into something extraordinary. An ordinary management can turn something extraordinary into nothing. Invest in companies not in stocks. Control your emotions and you’ll instantly have an edge over 95% of investors.
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“If you don’t know who you are, the stock market is an expensive place to find out” George Goodman, aka Adam Smith, Money Game, 1968
Thanks Sultan, great quote
Ian, I agree with everything you wrote except, “Invest in great management not great products.” Perhaps I shouldn’t take issue with one sentence in an excellent article, but it is very difficult for good management to overcome a business that doesn’t make a unique contribution in a marketplace. I remember, perhaps 30 years ago, reading Warren Buffett say something to the effect that he looks for businesses that don’t take a genius to run. I do also remember him offering the opposite observation (in support of your position) that he looks for businesses run by fanatics.
I say this having made many investments in mediocre businesses with new managements that had a strong track record elsewhere. I didn’t loose much money doing that, but didn’t make much either. To paraphrase Bernard Baruch, it isn’t the failures, the losers, that destroy you, it is the mediocrities that you keep hoping will get better that absorb your resources and prevent you from capitalizing on the truly great situations. The winners and losers make decisions easy or at least easier.
Businesses that create real value for their owners do something unique and important in a marketplace. Those businesses are very rare. They offer a similar product to others at a significantly lower price, or a significantly wider selection, or a truly unique, important product, for instance they dominate a niche. They do something, at least one thing, better than anyone else.
In an effort to try to identify these companies, I’ve been studying the career of Steve Jobs. How do we find CEOs like that? Cantankerous maybe, volatile, unpredictable, but focused on creating something exceptional in a rapidly expanding market. Not easy, but one success can make up for many mistakes.
Yeah I take a different bent, and in some ways I’m not talking about normal type businesses which I’m sure Buffett is referring to. I’ve invested in many companies where a mediocre management completely screwed up a great product/business. However I’ve invested in a few great CEO’s before who I know could turn a very mediocre business into a great one. In some cases turning literally nothing into something great. Of course this brings the questions, how do you know if management is great? This is much more qualitative as a resume is just a resume. Just because the guy/gal went to Harvard and had a great career at a fortune 500 company doesn’t make him/her a great microcap CEO. In fact they are usually the worst ones. Analyzing management is very qualitative. Similar to the book, “The Outsiders”, where the best CEO’s had very little if any management experience and less than half didn’t even have any industry experience and no previous successes. After meeting with many CEO’s, the good, the bad, the ugly, you sort of get a feel for what to look for.
“How many times have you painfully threw in the towel on a stock because it was dropping and the very next day it pops and moves back the other way. More than once right?”
lol, many times, and just this year. it’s painful to watch potential profits go down the drain because I was scared off by the irrational thinking of the market. luckily I put that cash to better use and ended up net positive, but no one can be lucky all the time.
could you ask your members about their ‘selling rules’ and blog about it? it’s a tricky topic, but important for beginners like me.
Thanks for the comment. Let me see what I can do on the “Selling Rules” post.
This has probably been the biggest area of growth and learning for me over the past few years, and I believe it has been useful in all aspects of my life. Not getting caught up in short term gain or dragged down by short term loss, is an incredible struggle to overcome.
I’ve come to try to foresee potential outcomes both on the upside and downside, and discuss them with my future self. Unforeseen events to both sides need to be addressed logically, not emotionally. Nothing has an infinite value, and negatives only cut value by so much. But keeping emotions under control is the only thing that enables this analysis.
Great article, Ian. Can’t imagine dealing with clients through a crash.
It will always be a struggle, especially hard in bearish environments where good fundamental companies still get sold off hard. It’s why it’s important to try to find the great companies run by great management teams. Always easier said then done
Great Post Ian.
As you have brought before – that’s what makes it so difficult to hang onto the multibaggers!!