Investing is a constant emotional struggle. Each point within an economic cycle breeds a different psychological state that every investor should be aware of. Controlling your emotions is arguably just as important as your stock picking prowess. The image below perfectly resembles the emotional lifecycle of an investor.
As you can see, the illustration is the prototypical buy high (euphoria) and sell low (Capitulation) trap that most investors fall into. Even though the goal of investing is the exact opposite – buy low and sell high. The irony in it is that human nature and logic are not always aligned. This emotional rollercoaster is much more difficult to navigate than it seems. However, if you can successfully disconnect your emotions and investing, you can begin to use this emotional cyclicality to your advantage.
When I first began investing after high school back in 2008, I picked up day trading and I thought it was the best feeling ever. Every time I placed a trade, my adrenaline was pumping and I felt like I could take on the world! Unfortunately, when you are making decisions based purely on emotions and adrenaline, it’s only a matter of time before your luck runs out. Luckily I was just a prototypical 18 year-old kid who didn’t really have much to lose. In all I think I lost about $2K, so not the end of the world. However, the experience taught me a great deal about mixing emotions and making investment decisions without any fundamental analysis backing each decision.
Conquering The Fear
The point at which to invest is the point when pessimism is at its highest. This is where having a contrarian mindset pays off. I’m not suggesting to time the market, because I doubt anyone can do that consistently over time. I do believe, however, that combining solid financial analysis and a general understanding of the emotional cycle will improve your odds of buying low and selling high on a more consistent basis.
In this era where we have access to information all day long, it makes it much more difficult to control your emotions. I get bombarded by CNBC alerts all throughout the day, which naturally forces me to read the latest news headlines. When I began applying my value investment strategy, it drove me crazy watching the prices of my stocks everyday and not seeing any meaningful improvement. This is after I’ve done a shit ton of research and financial analysis. However, I also realized that I had a long-term strategy in place and that these investment ideas wouldn’t shoot up overnight. These were all 5-10 year investment plays, maybe even longer. Changing my mentality from a day trader to a long-term investor was one hell of a turnaround. The biggest factor in controlling my emotions was to challenge myself to not look at the price of any stock I had invested in for at least 1 month. It’s almost like an addiction that needs to be broken. Imagine going without Facebook for a month!
Over time the day to day excitement and urge to check stock prices will diminish. This is a good thing. Before I make an investment I have already done all the research and analysis. So as an investor, I did my job. Now I just have to let my company’s do theirs.
Now that you know the investor emotional cycle, it’s time to use it to your advantage. Every day I keep reading that the market is overvalued and that there will be a huge market correction in the near future. As a contrarian, I try to think the exact opposite. Right now the market is hitting all time-highs, but you have to consider the current economic environment. Corporate profitability is at an all-time high, the economy is steadily improving and interest rates are really low due to central bank activity across the globe. That is much different from a bubble environment where there is a sense of euphoria. I don’t follow Bitcoin, but just reading the headlines and seeing people brag about how they became millionaire’s from trading this digital currency seems like a bubble. From what I can tell, the Bitcoin market currently has a sense of euphoria. The broader stock market, however, does not.
In reference to the emotions chart, I think we are closer to the point of “excitement”. This doesn’t mean the market won’t drop 20% tomorrow morning, but I think it is reasonable to see high asset prices continue for a while longer. As an individual stock picker, I keep a mental note on how the overall market is doing, but not all stocks follow lock step with the market. This is where an investor can earn his keep – finding opportunities that are being overlooked by the broader investment community. So while the overall market may be in the “excitement” phase, there could still be some good quality stocks that are in the “depression” phrase. These are the ones I want to buy.
As the overall market continues its march upward, the opportunity set becomes smaller. So a nice correction would bring bountiful opportunities, but until that time comes, my relentless search continues.