At times, Mr. Market becomes so wild. Its down by 5% in a single day, or sometimes by 8% or sometimes it touches lower circuit by going down 10% in just 15 minutes. Within a month, investors see their stock value going down by 50%. That 1 million (10,00,000) becomes 5,00,000 within just a month. Can you imagine all of a sudden, your savings going down by half? Will you think of investing in stocks when Mr. Market has got so dangerous mood swings? Many investors (along with me) are seeing this type of fall for the first time in their investing life. I was in my school when the 2008 recession occurred so I can’t remember exactly what happened then. However, how would an intelligent investor behave in this type of wild market fluctuations?
Throughout the history of mankind, we have noticed that there have been good days and bad days. In wall-street dictionary, we call them bull and bear market. An investor should know about the possibilities of these phases and be prepared both financially and more important – mentally.
The Most Important Lesson For Investor
I always used to wonder why do people sell stocks during a recession at low prices by booking loss. Because it gives others, the opportunity to buy at low price. And secondly what do people do with that money after selling these stock at low prices. Finally, I got my answer when I started learning about behavioral finance.
We have survival instincts built into our system so deep that as soon as we come across any danger, we immediately react without thinking twice. To be honest, its not a bad thing. That is how human species have survived thousands of years throughout the different ages. The moment you touch an extremely hot vessel, your skin sends an immediate signal to the brain and you take your hand back within milliseconds. We do not sit and analyze whether its good or bad. Right?
However, when it comes to investing in stock, it’s a little different. This is why you would often hear stories about people losing money in stock and never returning back. Our emotions have evolved to our greatest survival benefit. Hot emotions such as surprise and threat are experienced instantaneously and powerfully. These emotions signal an imminent threat to our survival which then initiates urgent action. That increases our chances of survival however, in stock market, it increases the chances of huge losses.
Studies in behavioral finance have identified that investors dislike a loss more than they like a gain of an equal amount. In simple words, a loss of $100 would give us more pain as compared to the happiness achieved from profit of $100.
Market Fluctuations vs The Intelligent Investor
An intelligent investor must behave consistently as an investor and especially during these market fluctuations. One bad day and emotional decision can lead to great loss. Initially, you’ll find its a constant battle between the pain to loss money or the desire to make more. This is why, you’ll never ever see Warren Buffet or Rakesh Jhunjhunwala selling at the times of recession. In fact, these tycoons usually buy more during these times when the people think the world is coming to an end.
Many people can’t resist looking at their portfolio which is in 40% loss. They feel the pain and immediately sell without analyzing it and understanding the current situation. They book the loss, then either dump that remaining fund in savings account or keep it in fixed deposit forever. If you have taken a loan or traded in stock with margin then you do not have any option but to sell when the prices go below your limit.
“But note this important fact: The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need to pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.”Benjamin Graham, The Intelligent Investor
There is a great level of learning in the quote above. Hence the moral of the story, control your own emotions. Its not a battle between you and others, its a constant battle between our own mind and brain. Self-discipline is the key because its very difficult to stay optimistic during different phases of recessions and market crashes.
Most of us would have experience of owning a multibagger stock. Just that we didn’t hold it for long and so never made big money.
We can either choose to believe that the world is doomed and there is nothing left for humanity or it would recover. Considering the history of humanity, I’m confident that the world would recover; even if gets worse before getting better. While taking precautions, I continue to remain optimistic.D Muthukrishnan
For The Market Timers
Now think about this one, it’s interesting! Can you predict accurately whether the market will go up or down in the next one minute? You can’t! (Although there is a 50% probability of getting it right because the market either goes up or down. But nobody can predict with 100% guarantee). Can you guess whether the market will close in positive or negative in next 1 hour? I assume no. By end of the day? May be. What about 1 month? Someone might! Can you guess what’s gonna happen in 1 year? I’m still not sure but the chances of accurate prediction keeps on increasing when you increase your time period.
Hence, if I ask you, what will the market close in the next 15 years from now? There are high probability that it will close in positive. Based on the historical data, we have seen the market grows with the economy and Indian market (Sensex) have been growing by more than 10% compounded in the last few decades.
Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of the company and the success of its stock. This disparity is the key to making money; it pays to be patient, and to own successful companies.Peter Lynch
I’m optimistic about the Indian economy and I believe in it. Those who don’t take action because of their understanding of risks in the market are taking the biggest risk. Because inaction is the greatest risk of all. It doesn’t matter how much you make, what matters is how you keep it and your behaviour towards it.
“The fault, dear investors, is not in our stars, not in our stocks – but in ourselves…”Benjamin Graham, The Intelligent Investor
Don’t forget to read: Smart Investing Strategy During a Recession