Charles Mackay, in his book ‘Extraordinary Popular Delusions and the Madness of Crowds’, explains how people lose their ability to think rationally under the pressures of crowd behaviour. This is why, at the peak of a bull market or the trough of a bear market, people tend to follow the crowd.
Investing requires flexibility; changing your mind is essential, but taking action on those changes is what truly matters.
Market volatility is a given and our past experiences often shape how we react to these fluctuations.
When markets rise, optimism abounds. However, caution is crucial, as risk is often overlooked during these times.
The rational thing to do is to move cautiously because, ironically, this is when most people ignore risk, even though it’s the best time to consider it.
On the flip side, during a bear market, pessimism takes over. Recency bias can blind you to opportunities when they arise. Warren Buffet wisely said “Be fearful when others are greedy and be greedy when others are fearful.”
Howard Marks once emphasised, “Most great investments begin in discomfort. The things most people feel good about – investments where the underlying premise is widely accepted, the recent performance has been positive, and the outlook is rosy – are unlikely to be available at bargain prices. Rather, bargains are usually found among things that are controversial, that people are pessimistic about, and that have been performing badly of late.”
In 2020, the stock market experienced a significant correction. The prevailing sentiment was that this downturn would continue, and the financial news was overwhelmingly negative. Yet, this was the ideal time for bargain hunters and the best moment to be greedy. Since then, the market has significantly recovered but human emotion often makes rational action difficult because recent experiences can heavily shape our views.
We humans easily fall into the trap of biases based on recent experiences instead of relying on data and making rational decisions.
The pain experienced from losing is far worse than the joy experienced from winning.
The same can also be said, we are less likely to gamble with profit than losses.
Reflecting on our experience with Nvidia, we sold the stock after a 240% increase because we couldn’t justify its valuation. As the saying goes, “No one has ever gone broke taking profits.”
In hindsight, waiting a bit longer might have been wiser, but at that moment, selling felt right. I guess sometimes, it’s better to be partly right than completely wrong.
We all carry scars from past market experiences that often prevent us from making the right decisions.
Does that mean proper learning requires a painful lesson? Albert Einstein once said, “The only source of knowledge is experience.” Painful lessons can indeed teach us, but they can also hinder us unless we follow a disciplined process.
The mistakes we made in the past often can be our worst enemy if we do not analyse them properly.
As an investor apart from battling with your own emotions, of course, there are external pressures such as your performance in comparison to the benchmark and following the crowd which dominate the sentiments.
We must play our own game in life because we are all psychologically conditioned differently. Some people learn well from pain, while others do not. In the investment world, some losses are inevitable. It is better to use a strategy that suits your personality and not compare your results to others. As former US President Theodore Roosevelt wisely said, “Comparison is a thief of joy”, therefore do things that are worth suffering for and always remember not to compare yourself with anyone as there will always be someone with better performance than you.
Our goal is to find companies with an unbelievably attractive, asymmetric payoff profile. When we find them, we invest significantly, as long as the upside potential remains compelling and wait patiently until the market recognises it. Ultimately, successful investing requires a disciplined approach, learning from past experiences, and maintaining a long-term perspective. That’s what matters most.
Awet Ghirmay, Head of Investment Research
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More information about our fund can be found here: Hargreaves Lansdown or AJ Bell
Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
