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.

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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?

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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.

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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.

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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.

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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?

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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.

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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.

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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.

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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.

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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

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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.

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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.

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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.

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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

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And when the pendulum nears to the extreme bearish situation then

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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.

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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.

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

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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.

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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.

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