BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “APPRECIATING THE ROLE OF LUCK”

01

While we involve into any of the investment decisions then those decisions are having dependencies on the future. As we know that future is uncertain and it is difficult to predict it. In such uncertain investment environments, luck plays an important role and we have to recognize the role of luck in our investment journey.

02

When we get some result or looking at the result then we must have to think the role of randomness in that generated result.

03

Many outcomes are visible to us but we have to think those outcomes with different viewpoints. If someone has made a risky & uncertain investment and he gets a good outcome from it. We can say that such outcome happens due to luck not due to skill. But people take such outcome as their skill, not consider a role of luck.

For example, baller throw ball towards stump for capturing a wicket of the batsman and that becomes the wrong throw and ball has touch boundary line then it is not a skill of batsman but the role of luck.

Many times, people get the return on investment by just being in the right place at a right time. Not due to their skill.

If someone has invested his fund during the year 2013 with just making a portfolio with random stocks then also that person generated a good return. Doubled your Money in Last 3 Years? Skill or Luck?

In short term, we can able to generate a good return and many a time achieved an abnormal return by just being in the right place at a right time. But what about the long-term result? How we can say that luck always keeps on favoring us.

04

Generally, during a boom period, the person who takes a higher risk get highest returns. But that is not the reason to consider them as the best investors. Very few people appreciate the role of randomness or luck in the life or in investment journey.

Mr. Taleb has mentioned the list of things which are generally mistaken by us.

05

We should understand that when things going right, luck looks like a skill and people misinterpret lucky investors as skillful investors. Many a time, we get an extremely good reward by chance and we make a mistake to consider such result as our skill.

That means batsman hit ball for six and that ball also declared “No ball” and batsman get free hit and he again hit another six on a free hit.

In short run, we can win and make good returns by an occurrence of chances but in a long run, our wise decision provides us a good reward.

06

When we realize that investment outcomes get an influenced by the randomness then we can able to focus on every event with the different perspective. Otherwise, we just thought that such outcomes happen due to our skills only.

We have made a list of assumption for the occurrence of events but we also should focus on the occurrence of other different events; which we may not have assumed. It might be possible that sometimes all other events have collectively more probability to occurred compared to the single event on which we have put the huge focus. Such ignorance becomes dangerous for our financial health.

07

Investing something like a mixture of both skills as well as luck. Investing is not a pure luck like a snake and ladder game or not a purely skilled by the game of chase.

While we play chase then we require a skill to protect ourselves from moves of an opponent’s. We cannot able to win chase just by waiting for the favor of luck and mistake made by an opponent. We have to create a scene where opponent commits a mistake and we can able to win a game.

Whereas, there is not a requirement of a skill in throwing a dice while playing a snake and ladder game.

2010-04-24_2130

But we generally consider our winning as our skill while we should recognize that we are winning a snake and ladder just due to a support of a luck. While we should reach towards 100, we should not forget that there is a snake on 99 number which can bring us towards number 7. And transform our success into failure due to highly dependencies luck. Similar happens to us while we play an investment game on the base of pure luck. We may win till number 98 and maybe that our fortune transforms into failure by destruction in our wealth. We climb many ladders, get many multifold return generator stocks but we forget that such occurrence is due to luck. If we do not have our skill involve in it, then our wealth get destroy. We should not forget that investment requires a luck but also it requires a skill. If we fully dependence on the luck then we should never forget a snake on number 99.

08

Advertisements

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “HAVING A SENSE FOR WHERE WE STAND”

01 WWS

Some category of people does not accept that cycle is unpredictable and largely unknowable, and those people put efforts for predicting the future. Few people ignore the cycle and adopt the buy & hold approach. They do not get aggressive or defensive with their investments in the cycle. Many people have wrongly understood the statement of Mr. Warren Buffett – “Our favorite holding period is forever.”

And the last category which is an appropriate approach for the investment. Such category of people accepts that cycle will occur. Everything moves in a cycle. Fundamental, psychology, prices, etc all moves in a cycle. We cannot able to know when existing trend will go, get the stop and start getting reversed. But we need to be confident enough that trend will stop sooner or later. No trend continuously keeps on going forever.

So that we should try to know where we are standing in the cycle rather than to predict timing and extension of the cycle.

02 WWS

By knowing where we are standing at the cycle, we cannot able to know what will be going to happen in the coming future. But we can prepare ourselves with a probability of occurrence of events.

I can’t change the direction of the wind, but I can adjust my sails to always reach my destination. – Jimmy Dean

Knowing present environment is not much hard compared to knowing future. We can come to know the present environment by observing the behaviour of participants around us, by observing our surrounding environment.

We have to focus on everyday events prevailing to the market. Such events provide us a rough idea of our position at the cycle.

Liquidity

SENSEX TGT

When everyone is aggressive in buying a particular asset then we must have to take care and be aware of the upcoming risk. We should be aggressive in buying a particular asset while everyone is in panic and selling particular assets.

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” ― Warren Buffett

We have to look around and think it by ourselves regarding present situations and make a decision that where we are standing in the cycle. What is market participants doing? What media is talking? Such questions need to be answered by looking at situations around us.

SENSEX 2024-2030

Liquidity 2017

03 WWS

When too much money getting deployed into few assets then huge liquidity drives prices of an asset, such price momentum is not due to its actual fundamental. And also at the higher valuation people are ready to buy an asset aggressively. People are ready to buy Rs.100 worth of asset at Rs.200-300-400…. With the bright future expectations.

We cannot predict when huge liquidity gets dry but as a contrarian investor, we can prepare ourselves for upcoming risk.

04 WWS

05 WWS

We need to check which side majority of our answers falls and as per it, we can make an estimation of the present situation. And can able to prepare ourselves for the situations. When a majority of our answers falls at the happy situation then we have to be cautious towards the present scenario and vice-versa.

06 WWS

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “KNOWING WHAT YOU DON’T KNOW”

01 KWDW

When we concentrate on the small part of the things then we acquire more knowledge regarding particular aspects. We need to work harder and harder to develop our skills by which we can able to know more than another person. Enhancing knowledge will be work like an edge for us to knowing our positions better than others.

Also, we try to identify that where we currently stand, what’s our actual position so that we can prepare ourselves for the further development.

When we predict upcoming changes then we can able to earn money from participating in that changes. But if we have predicted something which is not going to change then it will be near to impossible to earn money. If things do not go to change then we cannot able to earn money by taking benefits of those changes.

It’s very difficult to forecast future and people generally forecast future with regard to what has happened in the past.

So that forecast can get right some of the time but it should be consistent in the getting right every time which can be very difficult.

Some of the people stick to always bullish or always bearish view and keep that view for a longer period. So that sometimes they get right with their forecast. It does not mean that their forecast will be right all the time. If you toss coin 100 times then there are a half of the possibilities to get the head of the coin. We cannot say such outcomes as a consistent outcome.

02 KWDW

We have to check that how many forecasters have predicted meltdown of subprime crisis or again boom was driven due to huge domestic liquidity currently.

Forecasters are called as “I know” school of investors. They are more confident about the future and the things will work out as per their assumptions.

“I don’t know” group of people can able to guard themselves while they have to deal with the future at the macro level.

03 KWDW

We never want to invest for the future which is largely unknowable and on the other hand, we need to face unforeseen future without forecasting the future.

The biggest problems arise when we forget the difference between probability and outcomes. We cannot surely know the occurrence of future events but we can know the probability of the occurrence of the events. When we forget the difference between probability and outcomes then we start predicting future events with surety.

04 KWDW

Investors who ignored such limitations then they make mistakes in their portfolio and also incurred huge losses. Events do not always occur as per our assumptions and we have to be ready for it.

When we do not know the future then we act in a different manner such as we diversify, hedge to the position, taking less leverage, focus on today’s value over a future growth, etc. On the other hand, while we feel that we know the future or future event will occur as per our assumption then we start taking more risk, taking more leverage, play on making an assumption of bright future. If we know the future then we play an aggressive game. We not take a diversification and take a huge leverage.

When we know that there will be no obstacle comes to our way while we are driving then speed, carelessness will increase. And on the other hand, when we know that our way is clear but any obstacle can come on the road anytime then we drive the vehicle more carefully with a speed which we can able to control. Similarly with the investment, when we believe that future is knowable then we behave for investment in a different way and when we believe that future is unknowable then also we behave for investment in a different way.

As the road is clear while we are driving but anytime any vehicle can come to that road and we can able to meet an accident if we do not have a control over our driving. Similarly, if we do not have a control over our investment then any unforeseen event can destroy our wealth. We need to wear a helmet while driving for controlling risk and also take proactive steps while making an investment for guard ourselves against unforeseen accident.

05 KWDW

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “PATIENT OPPORTUNISM”

01 PO

We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment.

02 PO

We bought an investment in a panic and sell it at the boom. Such an opportunities, we get during the market cycle. But sometimes being inactive and wait for the opportunity works better in an investment. We should not be going for chasing an investment rather we should wait for investment opportunities to come to us. When we are chasing an investment then it might happen that we might not get an opportunity at a bargain. We only get bargain where the seller is motivated to sell and such opportunities provide us a bargain.

Every time a great bargain will not be available, cycle – pendulum not at an extreme where we can go against it. Many a time, Market situations are balanced and fairly priced. In that case, we have to make an investment decision from what is available to us.

03 PO

In cricket, we do not try to hit each and every ball. We try to identify proper pitch to hit and till that opportunities, we just need to wait for a proper pitch or just keeps on rotating strikes.

Same with the investment, we should always wait for the proper pitch which is in our competence area and then needs to hit on it.

04 PO

In investing, the penalty is the loss of our capital. And if we try to eliminate such possibilities of getting penalized then, of course, we only remain with the rewarding investment opportunities. But many a time, we also need to miss some winning opportunities for getting our perfect pitch. And that can be bearable compared to the penalty of losing our capital. Staying on the pitch is more important compared to sitting at the stadium and seeing dreams of playing well for winning the match.

05 PO

We should wait for the profit-making opportunities with the control on risk. If we lost our focus on protecting our capital then huge waiting period and higher returns also might not be able to provide us above average returns.

Many a time, we get lucrative profit-making opportunities but for getting those opportunities, we need to take a higher risk and sometimes, we do not even know that we are taking a higher risk.

Generally, people shift towards higher risk investments while they do not get desire returns from the safer investments.

Indian

Before the credit crisis occurs, people tend to take borrowing at a cheaper cost and make an investment into the high return opportunities with the belief of low risk.

06 PO

When prices are keeps on going higher and higher than, we cannot refuse to have a lower returns with the higher risk. Mr.Howard Marks mentioned few aspects while lower returns environments exist.

07 PO

There is no easy way to cope up with such situations. One major mistake people make is reaching for the returns and forgetting the risk. Always seeing dreams for making a century in every match and forget the risk of losing a wicket before hitting a century.

When there is a low return environment then we need an exceptional skill, high risk bearing capabilities and huge luck for generating higher returns.

The major opportunities for buying an investment comes where the holder of an asset are forced to sell it. Such situations create a bargain opportunities for us. When baller is frustrated and then only there will be a chance of occurring a mistake by him and that creates an opportunity for a batsman to hit six. But for hitting a six, we need to protect our wicket and need to stay on the pitch. We get a good opportunity to make a good score when baller is frustrated and throwing lousy balls; not when he is sharply bowling and chance to lose our wicket is higher. Or batsman is frustrated and want to make score then he will lose his wicket. Similarly with the investment; we do not get good investment returns while we are frustrated and want to make an investment or all our friends are earning & we have missed out opportunities. We get good investment returns while all are negative or frustrated and we have the capability to capture the opportunity.

08 PO

Sometimes question raised in our mind that seller can be well informed and rational also then why he sell something at the bargain price?

09 PO

When forced sellers come to sell their assets then market requires a liquidity to buy assets at a bargain price. So that the person who is waiting for an opportunity those only can capture such opportunities.

10 PO

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “FINDING BARGAINS”

01 FB

02 FB

In all the previous articles of the series, I discussed buying a cheaper assets / Investment. But buying cheap does not mean that we should go and buy anything which seems cheaper.

We need to prepare a list of investment ideas which are matches with our criteria, matches with our risk tolerance capabilities and exclude which are not matching with our criteria. There are not each and every idea which are compatible with our risk appetite, we need to work on the ideas which fall under our circle of competence. We get many ideas which can be good but not compatible with our criterion then we need to stay away from it.

Before eating a food, we need to know which kind of food we really like to eat. We do not like each and every food so as similar to it, we need to prepare a list of ideas which match with our criterion.

If we are managing the fund of others, then not only our risk appetite but also risk appetite of clients, we need to focus.

03 FB

The second step is to select an investment idea from the prepared list; which is suitable for the potential returns and risk ratio, value for the money scenario.

After getting the list of the foods which we like then we need to work on the place from where we get a food with requiring quality, where we get food as per our spending, etc. we generally do not prefer to visit the place where food is not available as per our taste and preference.

04 FB

05 FB

If we pay high valuation for the any of the assets then it is logical that our potential returns will be kept on reducing and might be chances of occurrence of loss starts increasing. We made an investment for generating returns and enhancing returns.

We buy food for fulfilling our hunger not for exhibiting of our food dish with expensive food. We sometimes eat expensive food, not on a daily basis. As not only expensive foods can able to fulfill our hunger similar to that not only good and quality investment can able to provide us returns.

We need to focus on the bargain through which we can able to generate a potentially higher returns with minimizing risk.

Sugar IT

As I quoted an example of a good fundamental IT & Pharma company with cheap sugar company.

We can see that if we have bought the comparatively lower fundamentally good stock at a cheap price than this stock has generated a higher return compared to the good fundamental stocks in last 5 years.

Good food means we get a satisfaction & fulfill our hunger from eating that food, and that never matter how much expensive or cheap it is.

In general buying good assets mean, the assets provide us high potential returns relative to lower risk and also has a low price relative to the value of an asset.

06 FB

07 FB

Mr. Howard Marks mentioned that while popularity is high towards stocks and people hates bonds, also many institutions shifting from bond to stocks; such situations provide a bargain for the bonds.

When the time change and people seek for more safety relative to the price appreciation then they start recognizing the potential of bonds.

Generally, people start recognizing the potential of the assets while the price of an assets starts appreciating. But people who have identified assets earlier, those can produce above-average returns.

When the restaurant is crowded then only people recognize the popularity of a restaurant. We make a decision by seeing how much-crowded restaurant is. If no one at a restaurant then we generally not prefers to visit by assuming that particular restaurant provides a low-quality food. Similarly with stocks, when everyone is buying particular stocks then we also run for buying those stocks with assuming high quality with high return. We do not check anything and follow the crowd.

We should try to make an investment into the underpriced assets rather than fairly priced. Fairly priced assets just provide fair returns with risk involvement. So that we should focus on underpriced assets with risk involvement for generating above-average returns.

08 FB

Bargain only available while perception is worse compared to the reality towards the asset. If everyone feels good and want to own that assets, then that asset will not be available at a bargain more.

When everyone cannot able to see the potential of the asset then we need to check the reason for unloved of the asset. Unloved assets can be available at the bargain if people hate it more than it should be.

If nobody is loved to the asset then nobody holding it So that demand for the asset will increase when people can able to see the potential of the asset. If our assumption has proven wrong and nobody is holding an asset or people unloved an asset then we might get limited downside or get the least loss from our investment.

When nobody to go for visiting a particular restaurant then we get foods at cheap cost with the proper quality for maintaining its customer.

09 FB

10 FB

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “CONTRARIANISM”

01

Many investors are following the trend for making their investment decision but for becoming a superior investor, we need to think in an oppositely.

As we have seen that for becoming superior investors, we need to develop a skill of second level thinking. Second level thinking provides us an opportunities to generate above-normal returns and also protect us from the loss of capital. We need to think against the crowd because crowd generally operates at the basic level of thinking rather than the second level of thinking.

If we engaged in doing what others are doing then we also get what others are getting. So for getting superior from others, we need to think differently.

02

When we are joining the herd then following the herd can be dangerous to our financial health. When people are highly optimistic then prices started moving upward, top-level starts to form. And when people are panicky selling then prices started to go down, bottom starts get the form.

03

It seems much easier while we are understanding the concept but it is a much difficult task while we put it into the action.

1) We never come to know that how far pendulum will swing, when it will be reversed and how far it will swing to the opposite direction.

When pendulum starts moving towards an extreme then we are not able to know the extract extreme point and from where it will start reversing. Overpriced stock can become more overpriced and cheaper can become cheaper.

2) We can be only sure about the reaching of the pendulum to the extreme level. We can just make an estimation that pendulum will reach an extreme, reversed it to mid-point and move towards opposite direction where it will reach to another extreme point.

3) There are many points which can influence the market behavior, many reasons which make pendulum to swing and not anyone strategy which is always able to generate a higher returns.

04

There are many examples where we can able to see the overpriced situations but we cannot be sure that such situations will reverse from tomorrow and starts going down. It can remain more overpriced and can keep on staying to the same situations for over a period of time.

Expensive

Cheap

We can able to see that expensive stock remains expensive for the longer period of time and cheaper get cheaper over a period of time.

Also, we cannot always go and make a decision to do the opposite of what everyone is doing. We cannot start walking backside as everyone is walking towards the front side. Just doing opposite of what everyone is doing, does not provide us profit-making opportunities. We need to analyse and make a logical reasoning then reach to the conclusion that we should go opposite or not.

Lossing money

If we just do opposite of what others are doing without doing proper homework then also we can able to lose our financial wealth. So that it is not only to take contrarian decision is enough but with it, proper homework is also required.

Sugar

If some assets are temporary getting hate by people & with our proper homework then making a contrarian decision on it help us to generate an above-normal returns.

If everyone like some idea than probably it has done well or doing well. And if everyone is liking some ideas then prices reflect those liking. So much risk involves when crowd changes their mind.  Price can fall significantly due to change in the mind of the crowd; which is harmful to our financial health.

We can able to create above average returns when we can able to buy an investment at the substantial discount. And the discount is available only when the major crowd is not liking it, not at where everyone is liking it.

05

For the protecting our financial health, we require having a skeptical mindset. When we skeptically analyze any situations then we will not fall in trap with the crowd. We have to always keep in mind that what can happen and what is the probability of occurrence of those events.

When a crisis happens than actually, we can able to see & believe in the negative side of the market. But we have to skeptically think regarding the negative side when positive waves going on. We always need to think that what can go wrong while everything is going in a good way.

06

If we believe in the story prevails among the market then we will definitely do what others are doing. We will tend to buy an investment at a high price with expectations of generating higher returns. We keep on buying overpriced securities with an expectation of another great fool will buy it from us. But we always need to keep in mind that while we are buying overpriced assets then we are only the great fool, no one else.

We will buy things which doing well and sell which performing poorly. Such actions resulted towards the losses during the crisis time, also we might not able to take benefits when things recover from the bottom. We remain followers not able to become contrarian.

We need to be skeptical enough for identifying the aspects that which is good for creating wealth and what is not good for it.

07

If we keep on follow the herd then we will not get a chance to evaluate situation skeptically and we will lose while the optimistic situation turnout as a pessimistic situation.

08

09

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “Combating Negative Influences”

In this article, I am going to discuss regarding the psychological factors which affect our decisions negatively.

CNI01

Market many times provide us an opportunities to earn superior performance through inefficiencies, mispricing, misperception, mistakes of other people.

But the question is why such opportunities come? What makes us different from other people? Why mistakes do occurs?

CNI02

We need to analyze data and reach the conclusion. In investing errors occurs not due to analytical factors but errors mainly come from psychological factors.

Let’s look at the few psychological elements which affecting the investment decisions.

First emotion is GREED – Desire for money.

Most of us are making an investment for making more money. If we don’t care about the making more money than we are not going to make an investment.
And also there is nothing wrong with trying to make money. The market and economy run because of our desire to make money. But we should remain careful with a transformation of desire towards greed.

CNI03

Real estate

Real estate sector in India in the year 2007-08 creates a bubble and huge jump in the optimism by everyone. Such situation resulted under the sharp fall in the value of the sector.

Deepak parekh

Due to an impact of greed, people hope that their strategies help them to produce higher returns without taking higher risk for forever. And due to this hope, many times people hold highly priced securities with expectations of more appreciation can be possible. Many times such expectations went wrong and prove that expectations were unrealistic and people have ignored the risk.

Opposite of Greed is FEAR. As similar to the greed, excess fear is also harmful to the investors. Excess of fear stops us from taking a constructive decision while actually, we require taking such decisions. Due to fear, many a time we cannot able to make a good investment and also lose the opportunity.

The third factor is PEOPLE’S TENDENCY TO DISMISS LOGIC.
Generally, it happens that people stop using logical thinking and they start doing work with an irrational mindset. Many a time, we are not ready to accept logical reasoning for the situations and work as per unrealistic scenario. We do not apply what we have learned in the past but get easily deviate from those learning.

CNI04

When market or a particular strategy starts generating higher returns for a while, then we started believing that it will continuously generate such returns without an involvement of risk.

Howard Marks called such situations as “Silver bullet”, the Holy Grail.

But is it really same strategy keeps on generating higher returns without risk?

CNI05

As Warren Buffett mentioned, when prices started rising then it affects to the reasoning power of the people. It led to mania and situations of mania results towards the bubble.

The fourth factor is THE TENDENCY TO CONFORM TO THE VIEW OF THE HERD RATHER THAN RESIST.

Many a time, we started Believing to the crowd and starts to take an action as per the crowd behavior. Though behavior of the crowd is harmful and dangerous to us.

CNI06

The fifth factor is ENVY. Envy comes into the picture when we are comparing ourselves with others. And envy works as a negative force which affects our decisions.

When we see that our investment is growing then we remain happy. But the time we start comparing our investment returns with investment returns of others then we become sad. Now, envy starts showing its color and we make decisions which we may not take or which may be harmful to the financial health.

It is very difficult to see the higher growth of other compared to our growth.

Dost-fail-ho-jaye-to-dukh-hota-hai-lekin-dost-first-aa-jaye-to-jada-dukh-hota-hai

The sixth factor is EGO. Ego gets satisfaction while we generated higher returns compared to others. And we are keeps on evaluating our return in the short term. While we should focus on the longer horizon returns rather than keeps on tracking returns in the short term and also try to get out of the trap of ego. Ego can be harmful to the financial health. We keep on demonstrates that how much we know much compared to others rather than focusing on how much we know and how much we do not know.

CNI07

The seventh factor is the CAPITULATION. It means investors give up towards the situations while economic and psychological pressure becomes irresistible.

Many a time, overpriced assets become more overpriced, and underpriced assets become more and cheaper. This scenario affects to the psychology of investors and repetitions of such situations inspired investors to give up towards the situations and make investment decisions without using logical reasoning.

CNI08

When few or all the factors combined then it affects to the investor’s decision making and that affects the market. This resulted in the mistakes and those can be expensive for our financial health.

Psychology in IPO is funny. When our friend is applying to IPO and we asked for the business then he doesn’t know about the business. But he is applying for getting good returns. And he continuously getting higher returns and such higher returns earned by our friend attracts us to make an investment into the IPO. And such situations keep on repeating & more people get involved into the IPOs.

IPOs

CNI09

CNI10

CNI11

Read for more detail: The Most Important Thing Illuminated by Howard Marks

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “AWARENESS OF THE PENDULUM”

In the previous article, we have seen that everything moves in a cycle. And if we cannot able to understand the cycle, then we must pay for it. In this article, I am going to discuss on moments of the pendulum and how we can take benefits of its moments.

AP01

what-is-oscillation_2

We have seen pendulum and its moments. Generally, pendulums do not always remain to the extremes, majority time pendulum stays near to its main point. And whenever pendulum moves towards its extreme then again it will come back towards either extreme. The force of the swing of the pendulum itself responsible for its reversal.

AP02

Generally, our behavior towards the situation is responsible for the swing of the pendulum towards extremes and also responsible for coming back towards its mean point. Investors see the situation with either greed or fear and reach to the conclusion. When people are greedy, they become more optimistic toward the situation and they want to pay any premium for getting that situation favorable. Vice-versa, when people feel fear, then they are not ready to buy the stock at the cheapest value.

Excess greed creates risk taking behavior and excess fear creates a risk aversion among the people.

AP03

As there are two major risks in investing – 1) Risk of losing our capital and, 2) Risk of losing opportunities. But when pendulum moves towards the extreme end, then one of the above risks will dominate our investment decisions.

When pendulum at extreme bullish situation then

AP04

And when the pendulum nears to the extreme bearish situation then

AP05

When things happen in a good manner, then people become more greedy and confident about the situations which bring optimism towards the particular situations. People forget the involvement of risk and ready to pay anything for getting the assets. Vice-versa when things not happening in a good manner, then people are more fearful towards the situations and realize the inherent risk. Such situations bring bargains for the assets.

AP06

AP07

Sugar prices

Sugar stocks

We can able to see that when prices of sugar were low, people not ready to make an investment in the sector, etc. at such situations provide us a bargain opportunities and when things start getting well, we can able to make a good return. Vice-versa when everyone knows about the story, then that story is there in the price. We cannot able to make an abnormal return or chances are high to lose of our capital.

Wise people recognize the bargain first, then others will follow them and run behind the assets for buying it at any premium price.

AP08

We have seen three phases of the bull market. As similar to it, the bear market also has three phases.

AP09

When everyone fears with the negative news, events and they start thinking that such worst situations remain forever. Major bottom occurs over such situations. When everyone forgets that tide can again come in and such situations provide us a bargain opportunity. Vice-versa when everyone thinks that good time never going to end and they can generate higher returns easily, people forget that tide can go out then major top gets formed.

SENSEX

Those people who understand swing of the pendulum then they have protected their capital as well as made the huge return during the year 2009 and year 2014.

When everyone fears from the situations and think such worst remain forever. When such situations arise then the person who analyses and conclude that things can go better he can generate a better return with lower risk. Vice-versa when everyone thinks that things remain better forever than that is a period of painful losses.

The pendulum never continues to swing towards an extreme, it will be reversed from extreme. Extreme swing of the pendulum is itself responsible for the swing towards the opposite direction of the pendulum.

AP10

AP11

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “BEING ATTENTIVE TO CYCLES”

In this article, I am going to discuss on cycles and reasons for the occurrence of the cycle. For becoming a successful investor, we need to understand cyclicity of the market, earnings, business, etc., then only we can able to protect ourselves from the destruction of our wealth as well as we can able to grow our wealth.

Cyl 01

We as a human also born, grow up and die. These cycles keep on continue. And like that company also came into existence, grow up and once it will close or might get some revolution.

(Click here for human life cycle – https://www.youtube.com/watch?v=SdprpVCIhu0)

Cyl 02

As like our life, Economy, businesses, products, earnings of businesses, etc. also rise and fall. It also moves in a cycle. Many a time people forget that everything moves in a cycle and that situation provides us an opportunity for protecting and creating a wealth. We should always keep in mind that nothing in the world keeps on rising in a straightway. It will rise to an extreme level and falls to an extreme level.

NMDC

The margin of the company increases when the price of the iron ore increases and margin fall with the fall in the price of the iron ore. We must have to understand the cycle for protecting our wealth.

The main reason for the cyclical behavior of the economy is human involvement. Human nature is not mechanical but humans are emotional and inconsistent. Many a time Humans take the decision based on their feelings, emotions which itself cyclical in nature.

When we feel good, we remain optimistic about the situations and reverse when we feel bad then remain pessimistic about the situations. Our psychological involvement pushes cycle to the extreme points and after that extreme point, cycle corrects itself to the reverse direction and then again come to the mean value.

Cyl 03

If we see carefully, then we can able to understand that more worst loan given at a good time rather at the bad time. Because people forget the cyclical nature of the economy, industries, businesses, etc. also the credit available at cheaper rate. And additionally, people break discipline. They start to borrow extensively which will be resulted into the burst of the credit cycle.

Cyl 04

Credit cycle –

Cyl 05

When we are happy then we might get happier for some period and then our mood turns to the sad and vice-versa. Our mood also keeps on fluctuating and that turns out to be our happiness or sadness. Sometimes we become extremely happy or sad, but that situation does not remain similar for forever. It will change, it will get normalized.

So, if the cycle is in a good phase, then it might be remaining more good for the period and then correct for the bad phase and vice-versa. It will not remain good or bad for forever. It will come to the mean value at some point in time.

The cycle only stops occurring while people take all decisions by being unemotional and rational. But it is not always happening and such human decisions which will be resulted in the cyclical behavior of the market /economy. And this is only the major reason for keeps on occurring cycles.

Cyl 06

B Cyl 01

High profit into the business attracts the competition. This competition will turn high-profit margin into the low-profit margin. And business will fall into the problem. Many players get close and get out of the business. Consolidation of among the players will happen and few players survived in the business. Those survived players will again be getting a good amount of business and the again cycle starts moving. No business keeps on growing for forever with the same pace of growth.

indian-it-overall-92-15

The growth of Indian IT is falling compared to initial days. Also, players among the industry and startup are rising rapidly.

Cyl 07

Cyl 08

We always need to keep in mind that everything moves in a cycle and when we forget it, we will be at the risk of losing our capital.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

 

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “CONTROLLING RISK”

In the last article, we have talked about the identifying risk and recognizing risk. Now, in the current article, we discuss regarding controlling the risk. Generally, in the market, we put much emphasis on the higher absolute return instead of superior risk-adjusted return. But the great investors are those who focus on the risk and generate moderate returns with low risk or high return with moderate risk.

Generating higher returns with the higher risk for a long time is rare in the market. The risk of losing money arises when our investment meets adverse situations and Loss does not occur till the negative events occur. We should always focus on controlling the risk because we do not know that when the negative situation arises and we met losses.

When we bought the home, we check that the home is constructed in a way which can be protected by earthquake or not. The similarly, we should focus on our investment. We should focus on the situations where the occurrence of such negative situations can destroy our wealth. And work as an earthquake in our financial position.

It can be possible that an earthquake will never happen in life long, but we bought the home which can be protected with an earthquake. Similarly, it may be possible that adverse situations will not arise during our investment time, but we should focus on raising of adverse situations and how we can able to protect our wealth from such situations.

The risk is not always easily visible. If our surrounding environment is positive, then we start thinking that negative situation may not arise due to the influence of that positive environment. But in fact, the risk is always present in the good environment also. And anytime good environment can easily turn out to the bad environment. Such transformation does not come to us with the prior intimation. We must have to be ready properly with such considerations before making investment decisions. Even controlling risk is becoming essential into the good environment because nobody is talking about risk and in a bad environment, risk takes care of itself because everyone fearing of risk.

Generating superior return compared to benchmark with the similar risk nature is a good performance. But, a good value addition is while we generate a return which is like the benchmark return with the lowest risk and with proper controlling of the risk. Such scenario is even better.

 

When the environment is positive, everyone rides the wave and we cannot able to say which one is better. (Good article – Doubled your Money in Last 3 Years ? Skill or Luck ?)

CR03

So that we should always focus on the controlling risk, whether it will rise or not. Because we cannot able to really predict the occurrence of the risk.

CR04

Careful investors always know that they cannot able to know the future so that they try to focus on controlling risk and try to factor the risk of loss of capital while they make any investment decisions.

CR05

We start avoiding focusing on risk as the environment is going positive. Initially, we might put weight on risk, but many times that risk might not get triggered. So that we start avoiding it and started believing that there is a no risk into the environment. Such risk will not occur and we saved from the negative situation.

As we have seen in Russian Roulette with 100 chances, we may save for 99 times, but the 1 time can kill us. Or if we are lucky we can be saved all the 100 times. It doesn’t mean that there is no risk or risk may not arise in the future.

Example – THE EVENTUAL CONSEQUENCES OF RISK SEEKING OR RISK BLIND BEHAVIOR

CR06

We constructed belief in our mind from our past experiences. If we have seen the positive environment, then we have made belief that negative situations never come. We should always keep in mind that occasionally extreme situations can arise and that can be out of our all belief.

In the year 2007, also welcome structured products, huge capital inflows, etc.

CR06.5

CR07

We should not run from the risk but should manage risk intelligently. We should take the risk, but at the appropriate time and most importantly at an appropriate price.

CR08

When we walk on a road with keeping our eyes closed and we do not meet an accident, then it’s not our talent, it’s a pure luck which plays out. We are a real blind if we consider such situation as our own skill. And such risky situations do not stay rewarding for a long period and we must walk on the road with keeping our eyes open.

Read for more detail: The Most Important Thing Illuminated by Howard Marks