Benjamin Graham: Master Your Emotions to Master the Stock Market

Warren Buffett's great mentor had some sage advice for investors struggling to control their emotions

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Dec 07, 2021
  • Graham was the father of data-driven value investing, but his insights extend beyond balance sheets.
  • A student of market psychology, Graham understood that emotions can drive the stock market.
  • According to Graham, investors must first conquer their emotions before they can find success in the market.
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Benjamin Graham is one of the all-time greats of stock market investing. Even a half-century after his death, his shadow continues to loom large. Graham’s work arguably did more than anything else to define modern value investing. His students have done much to evangelize his principles, none more so than Warren Buffett (Trades, Portfolio), whose Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) might best be described as Graham’s investing philosophy in corporate form.

Graham’s many and varied insights continue to resonate with value investors today, including his belief that investing success is the product of rational and dispassionate decision-making.

Emotion drives the market

Graham believed the key to investing success lay in embracing rationality. Unfortunately, that is often in short supply among stock market participants. Indeed, as Graham observed, emotion and sentiment are what tend to drive macro trends in the marketplace:

“The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists.”

Throughout history, markets of all kinds have proven extremely susceptible to psychological forces. The collective emotions of investors clearly play a massive part in shaping the direction of markets. The more intense the market’s emotional state, the more irrational its moves are likely to become. Faced with such a situation, the wise investor will ignore the noise and focus on the numbers, or as Graham put it quite pithily, “Buy not on optimism, but on arithmetic.”

Emotion is dangerous for investors

Graham considered extreme emotionality to be a universal characteristic of the stock market. However, he did not see this as necessarily a bad thing. Indeed, it presents both a challenge and an opportunity. The challenge is that, being human, any investor can fall prey to their emotions. According to Graham, people prone to emotional decision-making ought to give the stock market a wide berth, saying, "Individuals who cannot master their emotions are ill-suited to profit from the investment process."

To be able to act with conviction in the face of popular market opinion demands that one conquer one’s emotions. That is not something everyone can do, but it is a prerequisite of long-term investment success, as Graham explained:

“Though business conditions may change, corporations and securities may change and financial institutions and regulations may change, human nature remains essentially the same. Thus the important and difficult part of sound investment, which hinges upon the investor’s own temperament and attitude, is not much affected by the passing of years.”

My take

One of Buffett’s most quoted pieces of investment advice is to “be greedy when others are fearful, and fearful when others are greedy.” Graham offered much the same advice years earlier when he said, “Buy when most people, including experts, are pessimistic, and sell when they are actively optimistic.”

That is a sound strategy for value investors especially, but it can be easier said than done. Still, in my assessment, it is those investors who can rule themselves who ultimately rule the stock market.

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