If you haven’t read Part 1 yet, you can find it underneath this Blog on the ‘Educational Blogs’ page or simply click this link:
This next paragraph from the Article is interesting – it essentially says that all Market Participants can be a bit mad and prone to psychological errors but that these cancel each other out if these traits are common on both the Sell and Buy side of the market. Problems start when everyone starts thinking the same and this makes sense in my experience. For example, when Fear grips the markets and we get a general sell-off, then people are mostly thinking the same and there are lots of people selling and very few buying – it is only once it gets extremely low that the fearful Sellers dry up and the Buyers can then take the upper hand and before long the people who were Sellers now become Buyers and everyone starts thinking alike again and driving the Prices up. Herd mentality and all that.
“The presence of overconfidence alone doesn’t create an inefficient market. Indeed, a market with overconfident buyers and sellers on both sides creates a heterogeneous, diverse, and therefore wise crowd. But crowds tend to go mad (and thus inefficient) once investors all start to follow the same rules and think alike.”
We are really in the sweet spot of this Article now with another gem next up. I strongly believe in this and as a Long-Term Fundamentals Investor (note I use Charts for timing) I think it is really important to think independently and to be prepared to go against the Herd sometimes. For example, MPAC is one of my favourite plays at the moment but I have had to be extremely patient for a long time before the Market started to appreciate the value and to get the Share Price moving – this is classic Contrarian stuff really.
I think there is another Long-Term Investor vs Short Term Trader issue here and that is around being an ‘Ego Trader’. This is often seen as a bad thing and that we should ‘leave our Egos at the door’ but in reality I think the truly successful Long-Term Investors need to be a bit egomaniacal and you have to have very strong convictions and belief in your ability and your analysis and experience. Of course, when you are starting out this is not easy and it takes time but once you have a Track Record of a few years of successful Investing behind you then you can have a lot more self-confidence that despite odd short term setbacks and the countless silly mistakes that we all will make, you actually know what you are doing and can trust your own decisions. Of course there are few substitutes for experience and not many short cuts (although reading my Website might help on the short cutting) but learning from mistakes is vital and an unavoidable part of the game.
Again it is the case I think that a lack of clarity on whether you are a Long-Term Investor or a Short-Term Trader is a big problem here. For Traders it is vital to not have an Ego and to run with the Crowd but for Investors I suspect the opposite is mostly true. Independent thinking and self-confidence are vital (note, not over-confidence or rash behaviour or sheer laziness).
It is also related to the highly expansive subject of ‘Noise’ – if we pay too much attention to the Comments and Views of others then we tend to be unable to form our own views and we are too easily swayed by Comments which may be inaccurate or may simply be Noise rather than Signal (in this sense Noise is information that has no effect on a Share Price whereas Signal is stuff that makes Share Prices move. Obviously we want to track down and act on Signal but we want to minimize and ignore Noise.)
This sort of thing constantly reminds me of that Robbie Burns comment “I never read anything about a Stock I own that anyone else writes”, and since reading that I have started to behave more in that way and I am cutting out Noise as much as I can. I have no doubt it is beneficial to my Investing methods and results.
Earlier in this bit I mentioned ‘laziness’ – a quick word on this. The other day I was in the Pub with a mate and he pretty much accused me of being the laziest Investor he knows !! Anyway, after his bruises had tied down, I realized it was in fact meant as a positive thing and I have to agree that doing very little is actually beneficial to long term Returns. All too often we want to tinker and mess about with our Portfolios when in fact the far better approach is to put maximum effort into choosing the Stocks we allow into our Portfolio and once we have them the challenge is to avoid all the Noise and Siren Songs to force us to sell our Great Stocks. Seeing any Trading Activity as a chore and a pain in the posterior is a good mental state to help avoid you doing stupid ‘Boredom Trades’ and looking for reasons to Sell what is in truth a superb Stock that you know really well.
I just want to stress something as well. We should treat our Portfolios as an absolute Temple of Quality and we should put in a lot of effort and thought into choosing the Stocks that are allowed to enter through the Main Gates of our Temple and once they have deserved their place in the Church, we should be extremely reluctant to let them out into the big wide world again where there are copious Heathens and Devils. Choose well and then hold on tight (a bit of religious zeal probably won’t hurt !!)
However, there is another form of Laziness that I see all the time and it is really not pretty. This is simply where ‘Investors’ and ‘Traders’ ‘piggy-back’ on other committed Investors and just Buy and Sell as they do. Of course you can see why people do this but it is very dangerous because acting in this way you will never learn anything and what happens once your Guru Trader disappears? I remember talking to a fairly new Investor who did exactly this copying once and whilst things were going well he was all happy and stuff but once the tide went out, he was panicking like crazy and all strung out and not sleeping simply because he had no strategy, no understanding and therefore no self-confidence that only comes through effort and commitment and learning through doing. Don’t be lazy !!!
“Cutting through the behaviour-driven noise is no easy feat. But Mr Mauboussin reckons the best advice might still be Mr Graham’s call for investors to ‘have the courage of your knowledge and experience, and to act on conclusions even though others may hesitate or differ’.”
The next bit is a new one on me and I hadn’t thought about it much before (if at all). To be honest I am not sure if I fully agree with the paragraph – I think I see his drift but in terms of what we do with Stocks every day, even a slight improvement after a load of Bad News can be all it takes to send a Share Price shooting up. This is especially the case with Small Stocks. I guess he may be right at a Market level and I will bear this in mind – I have certainly seen it time and again where the first bit of Good News after a tough patch sees a Share Price jump up fast and then more Good News which comes out later gets a much more muted reaction (although to an extent this makes sense because the Valuation will be higher after the initial jump up.)
I guess it perhaps helps to explain how a Stock that is doing really well and has upwards momentum can often keep rising despite a valuation that can be very stretched. The Price might rise as News comes out from the Company that it is doing well but then it manages to keep rising for many days and weeks after this because the Good News is not fully appreciated after the previous run of positive Announcements and upwards momentum. It takes time for the Good News to really sink in. Conversely, when there is Bad News I suspect it tends to get baked into the Price very quickly as Fear seems to be a much stronger motivator to action than Greed.
“Mr Mauboussin also unpacks the related idea of overreaction, which is closely associated with the ‘contrast effect’. This is investors’ tendency to see good news as somehow more impressive when it follows bad news, and less impressive than it should be if it follows good news.”
Another great paragraph comes next. What Keynes is saying here is that Long Term Investors should strive for a mindset of careful thought and weighing up Information in order to make good Decisions on a consistent basis over many years. He makes the point that many ‘Professional Investors’ (think Fund Managers etc.) put very little effort into gaining this long term analytical and calm approach and instead they just sneak a short-term Informational Advantage over everyone else by getting access to superior Analyst Reports before everyone else and stuff like this. In essence they are front-running everyone else but not through much skill themselves (you can front-run by skill if you buy into a Great Stock before everyone else and you found it from diligent research and focus on Stock selection). From my experience I have to agree with this although of course many Fund Managers are extremely talented Investors.
Another bit of supporting anecdotal information around this comes from reading books like ‘Liar’s Poker’ and ‘Cityboy’ where Traders were dumping Stock on Fund Managers and suchlike – reading this is scary because it makes you appreciate just how hopeless and downright lazy many Professional Money Managers actually are. OK, these books were written a while ago but I am highly confident that not much will have changed. Humans are Humans. You can get hold of these books in ‘Wheelie’s Bookshop’ and they are both well worth reading for their insights into the Financial Services Industry and Markets and also for sheer entertainment value.
“Mr Mauboussin points to john Maynard Keynes’ observation that a professional investor’s skill is less to do with ‘making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing change in the conventional basis of valuation a short time ahead of the general public’, than adopting a long-term stance of reflection and judgement.”
This next paragraph from the IC article really smacks me in the mouth and chimes immensely with a lot of my current thinking around how to manage my Portfolio (I must get that bag of peas from the freezer…..). I might have mentioned this already but I am planning a Blog about my latest thoughts on Portfolio Management and I would like to get on with that one next. If I have mentioned it before, please bear in mind that often when I write these Blogs they evolve over a period of time so I tend to pick them up and put them down. In this case I released Part 1 to the wider WD World last week but this Part 2 is only half written at the time I am coming to it now. This means that I have sort of lost track of what I have already scribbled in it and this can lead to plenty of repetition and I am sure the odd inconsistency or ten !! Obviously I proof-read all my Blogs several times before they are published but again because of how I tend to pick them up and put them down (for example, tonight I have a one hour window before ‘Gold Rush – Parker’s Trail’ starts at 9pm and I am just trying to get a few more pages done), there is huge risk of ‘mishaps’ in the production !!
I am moving more and more to the idea that I want to run my Portfolio by being extremely fussy and selective about what I buy with a predominant focus on Great Stocks that I can hold for the long-term and to do as little Portfolio Trading activity as possible. The paragraph below is precisely about this and the logic is compelling for me. I love the bit about “short-term analytical impulses” and I see this as yet another form of ‘Noise’ which obscures our judgement and leads us to make sub-optimal and often downright counter-productive decisions and in its most simplistic form it merely causes us to over-trade. Such over-trading is particularly dangerous because it adds considerably to Dealing Costs and more importantly it makes us sell Great Stocks when we really should be holding tightly onto them and resisting all urges to get a divorce.
The bit about time frames also chimes with the Ben Graham saying which goes something like “In the short-term the Stockmarket is a voting machine, whereas in the long-term the Stockmarket is a weighing machine” (in other words, on short timespans the Market works on popularity and emotions and on longer timespans the value and the quality of the Business are what counts.) I agree with this 100%.
“These latter qualities, Mr Mauboussin suggests, are often overlooked or washed away by short-term analytical impulses. To demonstrate this, he cites nearly a century of US stock market data which shows that the longer an investor leaves their portfolio, the greater the chance they will see a profit upon inspection. In the short term, markets are unpredictable and volatile and after a day, the chance of seeing a profit is around 51 per cent. But after a decade, this probability rises to near 100 percent.”
The next paragraph logically follows on from the one we just read and it makes sense that the more you look at your Portfolio, the more you are likely to Trade and suffer the consequences of short-termism. I know of Investors who only look at their Portfolio once a week or once a fortnight or something – there is a lot of sense to this and certainly I can see the attraction of checking once a week. I am in the habit of checking the value of my Portfolio every day (you may have seen the updates I put out on Twitter) and I realise the limitations of this but I can hardly be accused of trading too often !!!!
I look at my Portfolio many times during the day using my ADVFN App on the Fone and this has to potentially run the risk of making me trade too much. However, I have trained myself over time to focus on what the Charts are doing and the Candlesticks and stuff and to read any News Items and Bulletin Board comments if relevant – I guess many of these are distraction activities to stop me trading but it seems to work and I do feel that I have trained my brain to focus on what matters (and crucially to avoid the Noise).
The bit about “amortising the information gathering and transactional costs over a wider time period” is interesting and I have to agree that spreading the information and knowledge over a long period of time has benefits. For instance, I am convinced that my 20+ years in the Markets has given me a huge mental database of information about a huge number of Stocks and I often call up this memory to help inform me about a particular Stock and to make decisions regarding it. Often the memories are Stock-specific and often it is knowledge about other Stocks in a Sector that help inform my thinking about a particular Stock. Clearly having such knowledge is highly efficient in terms of the costs and time of gathering information and helps with knowing where to go to find out stuff.
Of course, as with everything in Investing and in particular nodding to the psychological side of things, such a ‘database’ of memory can have drawbacks and I often find myself battling against these. For example, I have looked at Safecharge SCH a few times and thought it looked very promising (it reminds me hugely of Paysafe PAYS which I used to hold and it got taken-over), but a psychological issue I have with Tedi Sagi one of the SCH Directors, always kept me away (he was involved with Netplay NPT which I held and was bought out far too cheaply in my view) and lo and behold this week they got a Takeover Bid on a big premium !!!
On balance though I suspect the advantages of my memory built over many years outweighs the drawbacks.
"It follows, then, that the more frequently an investor checks their portfolio, the more likely they will suffer from loss aversion, and trade more frequently. By extension, a long-term and patient approach to investing also helps to lift returns by amortising the information gathering and transactional costs over a wider time period."
I really like this next bit as well. It has been clear to me for a long time that most people simply do not read Results Statements slowly, carefully and in detail – this can mean that people who do take time and effort over reading News and understanding it can get a big information advantage even from News and Results that are public and everyone can read. This arises for several mainly psychological reasons which are part laziness (reading a detailed Results Update is simply too boring and too much like hard work – which most humans actively try to avoid); part tiredness (human Attention Spans are probably 40 minutes to an hour and after this your ability to take in information drops dramatically. I take the view that any ‘work’ over an hour is probably a total waste of time and it is better to go off and do something else and come back to the ‘work’ later) and partly a lack of education, experience and knowledge which means that even if you do take time to read the full News Statement, you might not have the educational level to be able to understand it and extract the key bits of information anyway.
Often people simply don’t have time to read full Results Updates because they have a demanding job or perhaps family demands or something. Without doubt one of the big advantages I have as a Full Time Investor is to be able to work flexibly and to free up time to read things etc. The bit about complexity of the information is spot on as well – this in particular plays to the lack of education and experience that many Market participants have (or perhaps I should say “don’t have” !!)
It is also tempting to read summaries of Results Statements etc. written by other people, you know, the sort of stuff you can read everywhere from loads of different ‘News’ websites, papers and magazines etc. These days I tend to take very little notice of these – by definition lots is missed out and the big problems are around bias and Noise. It is far better to go to the Source for your information and interpret it yourself.
“However, this is expensive and often difficult work. But investors can still get an information edge by paying more attention to public information. Mr Mauboussin cites evidence that the cost of attention means inefficiencies are inevitable, and that it is therefore important for investors to ‘recognise that not all information is immediately reflected in prices’. By extension, the more complex the information, the slower its absorption by the market, and reflection in prices.”
This final sentence very much plays to the idea of Value as opposed to Price. It is when the Market displays inefficiencies which throw up Value that shrewd Investors and Traders can take advantage of. Yes, it is without doubt not easy to tell when opportunities are presenting themselves but by having a very deep understanding of how to value Companies and a patient approach to let the Markets come to you rather than chasing them, you have a good chance of being able to exploit such anomalies. By understanding Technical Concepts like a ‘Capitulation’ when a Stock that has been falling undergoes a spike in Selling at the Bottom which ‘clears the Market’ and enables the Stock to bounce back, Traders and Investors can get a clear edge and stuff like being able to understand and ‘read’ Candlestick Charts can help a lot.
The kinds of opportunities which he is suggesting here can definitely appear when the Markets have big panic Sell-offs as they tend to do quite often and in particular in the Autumn. But of course there are dangers in trying to find the Bottom and often it is better to buy on Break-outs and into Uptrends.
"His suggestion that investors should always be on the lookout for market participants ‘compelled to buy or sell securities without regard for fundamental value‘, is sage advice even if this is very hard to determine."
OK, that is the end of this one. I am quite pleased with how it has turned out because by taking these particular quotes from the Investors Chronicle article I have been able to introduce some related and useful concepts, and of course as always I have tried to keep it in the Real World.
This one breaks down how I report my Portfolio performance and also has details on the superb and FREE ADVFN App:
This one is about Price as opposed to Value and is an extremely important concept to understand (the link is to Part 2 and at the top of it is a link to Part 1):
This is a really old one about Bias:
And this is a really new one about my morning routine (behave, there is nothing about toilets and showers in this one !!):
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