United States: If the Price of Castles Fell, Would You Buy One?

Often we dream of obtaining things that we do not really want, simply because they appear desirable. Whether they are realistic or not is of little consequence. Extraordinary financial wealth, universal notoriety and/or spectacular intellectual or physical accomplishment are, by definition, not within the reach of most people. Still it is nice to dream about fulfilling these goals. The carrot just beyond our reach becomes a driving force that propels many individuals through calm and raging waters alike. To many of us, the aforementioned goals are common. However, to those that are faced with the obstacles of physical disability, terminal illness and the like, the dream is likely to be quite different. For the latter, just being able bodied and free to pursue life on life’s terms, without the shackles of unfortunate circumstance, is a castle of sorts.

You may be asking yourself what in the world does this have to do with strategic portfolio management? The answer is simple, and relates directly back to the title of this book. The Greed and Fear Factor. Understanding and managing these two emotions is as important to long-term investment success as the nuts and bolts development of a plan of action itself. Several very intelligent investors have witnessed the demise of their empire because of this phenomenon.

It has been said many times that absolute power corrupts absolutely. One might also say that even relatively small successes can be detrimental. Moving further back to the central theme of investing, let me explain. If you use the guidelines set forth within these pages and begin to achieve superior results with a declining degree of effort, inevitably there will be a growing sense of complacency. A euphoric feeling of being smarter than the market. No one, but no one, is smarter than the market itself! The guidelines and strategies described in proceeding chapters are about listening to what the market is telling you and heeding its’ instructions. Frustration builds when one tries to tell the market what to do and it doesn’t listen. Succumbing to this narcosis will certainly lead to a premature financial death! Greed is good, and so is Fear. One will provide the inspiration to rise above the norm, and the other will keep you honest! Remember this factor and make it an integral part of your investment strategy. In so doing, you will have added an important weapon to your strategic arsenal. All too often the acknowledgement and understanding of this factor is left in the barracks when the battle is at hand.

As previously stated, Greed and Fear are good. But too much of either is very bad. If the balance shifts heavily in favor of the former, a "greater fool" mentality will fester and grow. This becomes evident when established disciplines are suddenly deemed to be irrelevant. Self-confidence turns into blind faith. Chasing the latest fad sector or hot stock is accepted as normal behavior. At this point the individual has lost control and crossed the line between investor and gambler! Call it "grasping at straws" if you will, the ensuing results are almost always devastating.

Conversely, too much of the latter often leads to a debilitating situation. The investor develops a type of hysteria and paranoia. Again, discipline is tossed aside in favor of a negative emotional disposition. The individual may begin to sell in a panic, or freeze and do nothing, when action is necessary! Either way, a symptomatic loss of focus leads to an ever-increasing state of confusion and complacency. The desire for success takes a distant backseat to the desperate need to merely survive.

To avoid falling into either situation, and maintain a reasonable balance, you must make a conscious effort. This undertaking should be in the form of an ongoing and rigorous self-evaluation. Regularly ask yourself the series of questions provided in the appendix. Write down your responses and keep the answer sheets in your Investment Journal. (The development of said Journal will be discussed in a subsequent chapter) With the passage of time, and review of your responses, a pattern will become evident. This exercise will give you an unparalleled level of acumen. Honesty is required! Remember this is not a test in the sense of passing or failing. It is, however, akin to a military inspection. The desired result is to strengthen your emotional disposition relative to the management of your portfolio. Think of it as taking a dose of "financial vitamin see".

Up until now, this chapter has been about understanding one’s personal investment psychology. At this point the time has come to look at market psychology. A process that may be compared to looking at the subject of economics from a micro and macro perspective. In many ways the psychology of the market itself is little more than assimilation. A massive gathering together of millions of tangent behavioral patterns associated with its’ participants propensity to consume. Simply put, the whole is greater than the sum of its’ parts. To a large extent, the masses are influenced by a rather narrow minded and often inadequately informed financial press.

It is not so much a case of the blind leading the blind; more like the vision impaired attempting to lead a dispersing herd. One must realize that information provided via commercial venues is tailored toward attracting as much viewer attention as possible. The level of attraction translates into media ratings and/or purchaser statistics. These in turn are used to generate advertising revenue, and so on. Once again, what may at first appear to be a negative situation can be used as a significant opportunity! Stocks are not immune to the most basic law of any marketplace. Supply and demand. Whether the status quo is created naturally or artificially is of little consequence.

The supply of readily available existing corporate stock is relatively finite over extended periods of time. New issues are continuously being brought public at the same time securities of existing corporations are being absorbed through mergers and acquisitions or disappearing through bankruptcy. When the environment is extremely bullish, exemplified by both surging share prices and robust volume, initial public offerings reach a fever pitch. Conversely, bearish markets with decreasing price and volume often see a dramatic fall-off in the IPO market.

The financial press can’t resist milking either of these situations (bullish/bearish extremes). Nothing sells more cereal and automobiles than advertisements encapsulated by headlines or top stories emphasizing Greed and Fear. It is the stuff marketing executives dreams are made of. Learn to listen to what is being blown by this manufactured wind. When extremes are reached at either end of the spectrum, pay close attention to shifts in direction. While this practice is more an art than pure science, it offers the ability to ascertain when a significant opportunity (or hazard) is approaching. One should not base his or her investment strategy on this phenomenon, but instead be aware of its’ existence. Again, another weapon in your strategic arsenal!

By now it should be clear why it is important to read through these pages from beginning to end before you start the process of self-evaluation and plan development. Many of the concepts and ideas may at first appear to be abstract, foreign or obscure. The intent here is not to confuse or bewilder but rather to stimulate, inspire and encourage the application of unconventional thinking. Base your strategy on the basics and obtain a positive alpha.

© 2002 John R. Lipka