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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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We have a hard time investing with a downtrend, while judging that move as only temporaryTHE EMOTIONAL ASPECT Manias, panics, and crashes are the consequence of an economic environment that cultivates cupidity, chicanery, and rapaciousness rather than a devout belief in the Golden Rule. Peter L. Bernstein in his Foreword to Manias, Panics, and Crashes, by Charles P. Kindleberger, John Wiley & Sons, Inc., 2000 Human Psychology in the Marketplace There are no certainties in this investment world, and where there are no certainties, you should begin by understanding yourself. James L. Fraser This is perhaps the hardest chapter to write and that probably means its the most important. A writer friend once told me, as we exchanged experiences over a good dinner and a bottle of bulls blood wine, in London, that from his writing experience, the things that write easily are usually the worst and least useful. The logic of this is that what flows easily is no doubt loaded with preconceived notions, predigested thinking, and very little new, deep, penetrating analysis. I inserted that lengthy preamble to impress on you the importance of this chapter. For, although emotions seem to have little bearing on getting more market know-how, they are on the other hand the single factor most likely to keep you from using the know-how you accumulate, or using it correctly, or at the right time. EMOTION SPELLS TROUBLE Our emotions are our enemies in the stock market and in business generally. In bull markets, we become ebullient and tend to buy, buy, buy, almost blindly. We hear only what we want to hear. We want prices to rise so we act like a bull. This lays us wide open for the kill. Conversely, at the end of a bear market, fear, doubt, and lack of confidence grow until we are blind to the markets signals that a new bull market is beginning. But these are the extremes, the top and bottom. Most of the time is spent well within those limits. And, here, our optimistic nature does us great damage in a bear market, which is our primary concern in this book. As optimists, its awkward for us to try to make money by shorting stocks, hoping stocks will fall. A short sale seems risky since it is contrary to our nature. To profit from a bear market requires that to some degree we suspend our need for bullish hope over the short and medium term, and concentrate instead on expectations for a falling market. This goes against human nature, and when things look to become worse than they have been in the past, or the future looks, at best, ambiguous, we tend to assume the worst possible outcome is the only one. Though history proves that, over thousands of years, there have been very few apocalyptic times, we have a hard time investing with a downtrend, while judging that move as only temporary. The truth is that a short sale in a bear market is likely to make you more money, faster, than a stock bought long in a bull market. This is because the pull of a bear market is shorter term and propelled by fearthus, usually stronger. Because it is against our very nature, we will be constantly vigilant for signs of a reversal back to more comfortable optimism, so we are more likely to complete a bear market short sale at the correct time than we are to sell a stock at the top of a bull market. FEAR AND ITS CURE Fear is the most powerful emotion we have in bear markets, and probably in life generally. If we put fear under the microscope, we find it is usually based on the ambiguity of a situation rather than on a known bad outcome. We fear what we dont know, so we exaggerate the possible ramifications. It is therefore emotionally easier to deny the existence of a bear market for as long as possible in hopes that it will go away and you dont have to deal with it. Unfortunately, that approach is the sure road to shrinking assets. The cure: increasing our knowledge in these areas where its needed. Step up our knowledge of bear markets, depressions, recessions, and the tactics needed to profit from these situations. As we do this, our fear will diminish, though it may never totally disappear. It may give you courage to know that the biggest fortunes of all recorded history were often made when things were at their worst. Someone recently said courage is a vital need in the market. To be a really successful investor, you must have extraordinary courage. You will be fully invested when the majority are afraid to venture. You will be in cash when most are still buying their heads off. Bear markets seem to require an extra measure of courage. Rothschild once advised, Buy when the blood is running in the streets. He said it all. I can only expand on this theme. In the 1929 crash, several millionaires were made, not because they had big fortunes to do it with, but because they had big know-how. THEORY VERSUS REALITY You can have a system or an approach to market investment that works beautifully on paper but falls apart in practice. Why? Because, when it comes to turning decisions into actions, the emotions dictate part of the answer. When its real money, the decisions are harder, the heart beats faster, and our fears or euphoria come boiling to the surface. Whats needed is realism and just plain common sense. But thats an easily spoken mouthful of words, and damnably hard to practice. DANGERS OF EMOTIONAL DECISIONS The French sociologist Gustave LeBon wrote 100 years ago: The crowd has never thirsted for the truth. It turns aside from evidence that is not to its taste, preferring to glorify and follow error, if the way of error appears attractive enough, and seduces them. Whoever can supply the crowd with attractive emotional illusions may easily become their master, and whoever attempts to destroy such firmly entrenched illusions of the crowd is almost sure to be rejected. However, there is hope. There is one way the masses can be convinced of the truth. Naturally, its belated. LeBon put it this way: An often repeated reference to past experience is almost the only effective process by which a truth may be firmly established in the thinking of the masses. Thus, false illusions that have grown dangerously large for the publics own good may eventually be destroyed. To this end, however, the truth as illustrated by past experience must be brought forward in various manners on a large scale, and this process should be repeated frequently and emphatically. When we read things like this, we like to think they are talking about all other people. We think that the public never includes us. But in fact it does. NO EXCEPTIONS Emotions are the common denominator that makes us all the same, and they can bring down the mightiest. Emotions have separated a king from his throne more than once. The examples are endless. They provide that, unless we can control our emotions or have some measure of control, they control us. Emotionally-backed decisions (especially in the stock market) are invariably bad ones, if emotion is largely what supports them. BE CONTRARY One of the reasons our emotions get us into trouble in the stock market is that the essence of being human is the need to belong, to be part of the group, and its easy to be swept up in a wave of either euphoria or pessimism. Again, knowledge is our best defense. In my chapter on contrary thinking (Chapter 18), you will see that the best vaccination you can give your brain is to reject everything automatically. Then, after rejecting it, you can study it and see if it merits accepting. This cooled off method of thinking will enable you to control your emotions to a large degree. FULL CONTROL UNLIKELY AND POSSIBLY EVEN UNDESIRABLE Mind you, complete emotional control is probably impossible. But if you simply step up your thinking and control processes, youll be ahead of the crowd. And when you fall short, take comfort in the fact that the really huge fortunes made on Wall Street, particularly during times of financial distress, were made in the main by people who lacked the normal social bonds to friends and family most of the rest of us need to be happy. I am not even suggesting that you strive to acquire this level of control. Merely that you never lose sight of what your basic common sense is saying, no matter how euphoric or depressed the mood of your fellow investors becomes. STUDY OF CROWDS If you study the psychology of crowds (there are several books on the subject: e.g., The Crowd by Gustave LeBon and Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay, both classics), you will see how peoples behavior, like most things in life, tends to go from one extreme to another. People become irrationally bullish or bearish, which is why price swings go to extremes. KNOWLEDGE AIDS OBJECTIVITY All knowledge is useful in the stock market. It is made up of the thinking and emotions of people everywhere and is under the domination of the sequential influence of cause and effect. The more you know about people, about human behavior, about business, about market, economic, and social history, the better able you are to cope with todays market. Much of what we do by way of evaluation and decision making comes from processing the present in the light of past experience, either what we have read about or have personally experienced. This often happens subconsciously. So the more you know, the more realistic will be your market judgment. MOST BELIEVE THEMSELVES OBJECTIVE Most people believe themselves to be clear, calm, unemotional thinkers who reasonably weigh all the facts. Most of us, however, are either unwilling or unable to analyze ourselves accurately and objectively enough to be a lasting success in the stock market. However, there is a twist here. Women are generally regarded as the more emotional sex. Yet, I know a number of couples where the man has too much ego invested in the prior buy decision to sell when the time is right. But the wife does not. In one case, they deliberately set their account up in different names so that when the time is right to sell, and the man is emotionally unable to execute the trade, his wife does it and tells him about it only after it is a fait accompli. Perhaps, on a deep level, women have a greater sense of survival than men because, ever since cave-dwelling days, the ultimate responsibility for the family has fallen on the woman. Hence, while men have this battle between survival and ego, women have no such conflict. My experience has shown that those who do achieve some measure of objectivity and emotional control readily admit they have a problem and that it is hard to beat. Its like knowledge. Those who think they know all the answers, in reality, often know very little. Those who know a great deal feel they know hardly anything. The more you learn, the more you find there is to learn and the less arrogant you are about what you think you know. There seems to be a measurable emotional sequence. In order: fear, pessimism, despair, caution, desire, confidence, faith, hope, enthusiasm, optimism, exuberance, and greed. But none of what I have said so far means you should try to react unemotionally. Thats impossible. But you can examine all the evidence you have, and then have a conversation with yourself, as a sort of devils advocate, alter ego, to convince yourself why your first emotional reaction was wrong. If you act on emotion and dont dampen it with factual reasoning, you are likely to make bad investment decisions. EMOTIONAL CONTROL If, to get a broader viewpoint, you study every available market approach and every technique, plus give yourself a good background knowledge of history, you will find that your emotions become more stable and manageable as your expertise and knowledge expand. INTUITION AS A MARKET TOOL Human judgment is at its best when it is based on reasoned conclusions that are the result of massive research, but tempered with intuition, which when used properly is an emotional gut feel based on complex patterns of knowing, where we are not conscious of how we arrive at this (usually emotional) conclusion. We all know more than we think we do. As we go about our daily lives, our brain receives information that we are often not aware of. We sometimes dislike people when we first meet them. If we are decent human beings, we will dismiss that gut feel as irrational, and go out of our way to find their good points. Yet, more often than not, our first impression is the right one. Somehow, the complex signals of facial and body language told our subconscious minds things about that person that we did not know consciously. How many times have you heard the story that even though it took many months to formally decide to marry, within the first hour of a couples first meeting, one or both of them knew they had found the person they wanted to marry? Studies have been done of what makes a successful business leader. And, time and again, it is discovered that the truly brilliant business executives trust their intuition as much as their reason when making major decisions. It is said that Einstein would intuit his theories and then go back and find the mathematical grounds for why they were true. But intuition, though apparently emotionally based, is very different from using emotional wish fulfillment as the basis for investment decisions. We all know a lot more than we are conscious that we know. And the more we consciously learn by research or experience in any given field of endeavor, the more we should trust our intuition when making decisions. It is for this reason that in earlier chapters I advise that you manually create your own charts for at least a few months, before you rely on an online service to provide them for you. Doing them manually will help develop a feel for the markets in ways that simply accepting ready-made charts will never do. But, though I advise you to cultivate stock-market intuition, I also warn you to be ever aware of the difference between a genuine gut feel for the near future, and an emotional desire for that feeling to be true. ECONOMISTS USE PSYCHOLOGY TO PREDICT ECONOMICS In recent years, a trend among economists is to consider social, political, and cultural factors as predictors of future economic growth or contraction. Perhaps the first advocate of this was Nobel Laureate F.A. Hayek, who began his career as an economist but very quickly turned to sociology and philosophy for answers as to why some countries are successful and some are not. In 1944, his book, The Road to Serfdom, was published in London. It explained partly in economic and partly in political and philosophical terms why communism doesnt work. It had limited success. As late as the 1960s, economic departments both in the US and in Europe had a problem with his holistic approach to the study of economics. But times have changed. In 1997, Nobel Laureate Gary S. Becker, in The Economics of Life, addressed how social and political issues influence economic decisions. The following year, Harvard economics professor David S. Landes, in his book The Wealth and Poverty of Nations, drew the conclusion that the difference between success and failure depends on political and social belief systems that cultivate the values of work, thrift, honesty, patience, tenacity. That: If we learn anything from the history of economic development, it is that culture makes all the difference. Robert William Fogel, Nobel Prize winner in 1993, takes holistic economics even further in his 2000 book, The Fourth Great Awakening and the Future of Egalitarianism, arguing that America is in the midst of a new wave of religious renewal, which will have profound and positive economic effects. None of these books will tell you how to channel your emotions in a positive way in order to make profits in the stock market. However, they do demonstrate that the study of economics, and by association the stock market, is no longer regarded as only an inductive science. But, because economic activity is a deeply human activity, it is only by studying humanity in its wholeness, complete with its emotions and its political and religious beliefs, that we can make sensible decisions about what the future will look like, and what stocks to buy and sell. In short, the way to deal with emotions is to factor them into your investment decisions, to channel them in a positive way, instead of pretending they do not exist. And, most of all, know yourself and how your emotions affect the decisions that you make. SPECIAL CAVEAT If you have a big, personal, emotional problem such as divorce, separation, litigation, you will be wise if you get out of the market completely until your problem is resolved. HELPFUL HINTS 1. The stock market is the most difficult (as well as the most interesting) place of all places in which to make money. When you increase this difficulty by letting emotions dictate decisions, you make the odds insurmountable. It may be oversimplification, but it is largely true that if a person is well adjusted with a good connection to friends and family, he or she can make a good emotional adjustment in the market. If he or she has a number of personal emotional problems, then it will be more difficult for him or her. So, make sure you know yourself, your limitations, your risk tolerance, etc. 2. Research, read, and then read some more. Expose yourself only to the best-quality advisory services. Study all history, not just market history. Take time off to relax and be with your family. Associate with successful investors (they will be the ones who dont, as a rule, claim to be). And learn to think contrary. Rather we should say that the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion. Benjamin Graham and David Dodd |
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