Our emotions are our biggest enemy, at least when it comes to investing. We should all know this. If you don’t, stop making your own investment decisions right now.
Our emotions lead us to do the opposite of what we should be doing. They lead us to buy high and sell low. They make us excited when we should be scared, and scared when we should be excited. They make us slaves to the stock market; they let the market become our master.
The market is there to serve us, and not the other way around. It is okay to have emotions; we’re human, after all. But what we really need is an investment process. This is system of rules that we follow that keeps emotion in check.
Now, I hate republishing old articles. But a few, the ones that focus on the process, I’ll recycle (and improve upon) for a long, long time. I wrote the following article, in 2007. I included it in my book. I’ve shared it with readers in the past. And I even wrote the flip side of it in October 2008, addressing the impact of a cyclical bear market on out psyche by cyclical bear market.
I’m not offering it now to provide a hidden message that I think the current (cyclical) bull market is over. I don’t know that. I just want to remind you (and me) that a rising market has an impact on our psyche, our analysis and our decisions, and we need to be aware of it.
You are not as smart as you think you are;
psychotherapy for (cyclical) bull markets
Lately I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret way to follow Will Rogers’ advice: Buy stocks that go up, and if they don’t go up, don’t buy them.
No, I didn’t get much smarter, and my stock-picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are the same way a bear market makes you feel dumber than you are.
Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make us careless. We forget about risk since we haven’t seen it in a while and focus only on the rewards. You have to actively make yourself aware of the four-letter word R-I-S-K!
How do you do that? My favorite way is to remind myself how dumb I am. I pull out an annual return report of a company on which I lost a boatload of money and masochistically try to read it from cover to cover, reliving my errors.
We all have these stocks, the ones we lost a lot of money in because we were overconfident. We tend to forget about them during a bull market. But I suggest you remember them now, so you’ll have fewer of those names to remember in the future. Risk is still there; it is just hiding under the joyful sentiment of the bull market.
Believe me, it will show its ugly face. It is just a matter of time.
In a bull market, it is easy to forget about selling discipline and then turn into a “buy and forget to sell” investor. Every time you sell a stock, you look dumb because it usually goes up afterward.
I recently sold several stocks, shamelessly, paying absolutely no attention to the fact that after I sold, they went higher. I don’t feel smart about that decision. However, when I bought those stocks, I set valuation targets. When they approached the targets, I quickly reviewed their fundamentals. They had not changed much. The decision was obvious — sell.
Cyclical bull markets teach us not to sell, while cyclical bear markets teach us not to buy. If you let the market tell you what to do, you have no process.
But the bell doesn’t ring when bull or bear markets are over.
You cannot worry about marking the “top” in every sell. My objective is not to buy at the “bottom” and sell at the “top.” My objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.
About the author:
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email or read his articles click here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy’s book Active Value Investing (Wiley, 2007).