Friday, 27 April 2012

Investment psychology: Follow your convictions

The hardest thing to do as an investor is to invest against the market.  There is a certain comfort in doing what everyone else is doing - the 'pack logic' for lack of a better expression.  However the really good returns from investment don't come from these investments - they come when you have gone against the market.

The catch in the above statement is that the market needs to have been wrong and you need to have been right.  As this is an unknown it requires conviction on your behalf in your valuation thesis and in your own abilities.  I was watching a documentary recently on Warren Buffet and almost everyone has heard of his concept of 'Mr. Market'.  That the best time to invest is when the market is offering you a price that is either too high (that is when you sell) or too low (when you buy).  Underlying the ability to take advantage of this is an investors conviction that they have done the legwork and have the 'fair price' in their mind.

While the concept seems rather simple and easy to follow, in practice it can be quite difficult which I know from personal experience.   I was invested in the US S&P500 index last year because I thought the market as a whole seemed cheap because sentiment there was terrible (and I had the benefit of not living in a country and share market that was experiencing a bull market) and the exchange rate was working in my favour.  I invested in this market however a few months later saw the value of my holdings slide ~10%.  I actually knew that this made the price of the index ridiculously cheap and I should have piled more money into it.  However I didn't because I found it too hard to swim against the tide of negative sentiment.  It is even harder when you are talking about a more risky investment (e.g. a micro cap stock) because this is when the thought of throwing 'good money after bad' keeps entering your mind even though you have done all the necessary analysis.

Note that it is just as hard to stay out of the market when you think it is overvalued.  This is because as it keeps going up you are acutely aware that others are making money in the market and perhaps you should be as well.

If you can develop an internal fortitude though and an ability to ignore sentiment then you can profit handsomely.  Note that this comes with a big caveat - often the market is right and you are wrong and you need to be willing to admit that you are wrong and exit bad trades. 

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