It's not all that surprising then that you decide to sell the bonds when your broker calls the next day with the news that the securities have sold off sharply and are now at a value below the price you paid for them. From the point of view of your original analysis, the reason for the decline is immaterial. You have liquidated your long-term position because you have lost your sense of perspective and ability to think independently.
This is just one example of what can happen in an actual trading situation. Usually this process will be much more subtle and will play itself out over a much longer period. In effect, the desire for news and price quotes becomes a kind of drug on which your emotional psyche needs to feed. As with all drugs, it takes ever greater amounts to maintain the same level of "high." In this case, the dose takes the form of more and more calls to your friendly broker, more often than not resulting in the pyramiding of positions to a very unhealthy level. All addictions are unpleasant to kick, and this type of predicament is no different. In this case, the withdrawal symptoms typically assume the form of devastating losses, as the market slowly but surely assaults every badly conceived position that you have taken.
The obvious way to overcome this problem is to take a leaf from Livermore's book and try to stop such frequent contacts. I am not suggesting that you should never look at price quotes or read the news, because everyone needs to do that from time to time. However, if you keep these contacts to a minimum, your investment results are bound to improve.
One way of lowering exposure to unwanted clutter is to deliberately structure your decision-making process so that purchase and sell decisions are made only when the markets are closed. A particularly busy person may decide to do this over the weekend when there is more likely to be adequate time for contemplation and reflection. You should also do your research when the markets are inactive. In this way, news events will have a less impulsive influence on your decisions. If you are an active trader, it makes sense to use technical analysis to make trading decisions. Leave orders ahead of time with your broker based on the probable action of certain stocks. Your decisions about when to enter and exit the market will then be based on cold, predetermined criteria and not on hot impulses and you will get in and out because of predetermined market action not on an impulse.
Gossip, Opinion Experts, and Gurus
Virtually every book on market psychology warns us against paying undue attention to gossip and rumors. In the old days, this used to take the form of one-on-one contact between brokers and clients, for example. Today, gossip takes other forms. Newspaper and TV reporting may be viewed as a form of institutionalized gossip. A recent variation of this phenomenon is the growing popularity of gurus, who, in many instances are a human substitute for the financial Holy Grail. Let us look at each of these in turn, starting with the general gossip'and rumor mill.
Broker, There's a Loss in My Account
The information lifeline of the vast majority of investors is their broker. In most instances, however, people are far better off thinking for themselves than taking the advice of a broker. There are exceptions, of course, and most brokers when asked will count themselves in this category. Never forget, though, that almost all brokers obtain their income from commissions, which naturally sets up a conflict of interest. Experience tells us that the most successful investors are those who hang in for the long term, rarely selling their holdings. This policy contrasts with the objective of the broker and his management. Their idea of success is to maximize commissions.
In reality, a good and successful broker, who looks after his customers' long-term financial well-being, will find that the commissions take care of themselves through referrals from happy customers, growing accounts, and so forth. The unsuccessful broker will be the one who churns the account through constant switching of positions. His clients will invariably lose money, and he will lose their accounts. He will gain over the short run but lose over the long one.
Even if you are lucky enough to run into one of the select few brokers with a mature attitude, there is still no substitute for thinking through each situation for yourself. If you are unable to set realistic profit objectives and decide ahead of time the kinds of conditions or events that will justify the liquidation of a position, you will certainly be more susceptible to news stories or other digressions that even the most enlightened broker will put in your way.
Do not be fooled by luxury sedans and smart clothes, they reflect merchandising ability, not market acumen and success. Brokers also deal in fashion when recommending financial assets. Most sell the merchandise that is sent out from the head office. This could take the form of research on a stock, a "hot" new issue or a "can't-lose" tax shelter. Some brokers will sell their clients anything that has a large commission attached to it. This is hardly different from a car salesperson who receives an extra commission for selling a particularly slow-selling but heavily stocked car. Brokers in large offices often get carried away by particularly aggressive colleagues. In such a competitive environment, it is easy for your broker to recommend individual issues without a careful examination of its underlying value and prospects. The attitude is: "After all, if Charlie is selling it to his clients, then it must be all right."
Never forget that it is your money and that you are the boss. Consequently, you must do the thinking and are the only one who should make the decisions. Use the broker as a source of information to help you to arrive at more enlightened conclusions than you could have arrived at on your own. Use the tremendous research resources to which most brokers have access. After all, your commission dollars are indirectly paying for this information. You might as well take advantage of it.
Differentiate Between Facts and Opinions
When considering a particular piece of news or the news background, it is important to differentiate between facts and opinion. In almost all instances, it is the news and the stories behind the news that merit further study. Opinions do not. Moreover, general news rather than stock market news is usually more helpful in formulating a view on the future direction of prices. This is because the freshest market news, unless it is unexpected, has already been factored into the price structure. On the other hand, the general news reflects underlying economic and financial trends that unfold slowly. They are also more difficult to detect and are therefore not generally discounted by the market.
Beware of Experts!
When it comes to opinions, we must remember that the experts are no more immune from personal biases than we are. In almost all instances, they consciously or unconsciously color what they say or write. In Speculation, Its Sound Principles, author Thomas Hoyne warns us that we should never "accept as authoritative any explanation of any person for a past action of the market." Hoyne justifies this on the ground that we should think these things out for ourselves. This practice, he claims, gives us the best preparation for deciding what may happen in the future. We always feel more comfortable if we can come up with a rational justification for a specific price fluctuation. Just think how an "expert" feels when someone calls up from The Wall Street journal to ask why the market fell today. The expert must either come up with a plausible explanation, or risk looking uninformed by replying, "I don't know." The same is true of your broker or anyone in the position of being paid to "know." In essence, long-term swings in the financial markets can be rationalized by the changing perceptions of investors toward basic changes in economic and financial conditions. Unfortunately, that sort of explanation does not sell papers or maintain viewers, so the media are forced to resort to the more rational price movement justification approach.
The problem of literal interpretation of news reporting is made even worse because financial reporters typically contact several analysts to get their views on the day's market action. From these reports, there emerges a sort of consensus from which the journalist can create a headline. A typical article appeared on September 25, 1990. The headline read "Bond Yields Hit March 1989 Levels." Anyone picking up the
paper and reading the article would come away with the distinct impression that yields were headed much higher and prices much lower because of soaring oil prices, and so on. However, several days later, on the 28th of September, the same market advanced and the headline read "Treasury Bond Prices Jump After Nervous Investors Bail Out of Major Banking, Financial Issues." Anyone making a decision to sell based on the article would have been wrong, because the price then went back up again. (See Figure 3-1, points A and B.)
Figure 3-1 Government Bond Futures November 1990. Source: Pring Market Review.
This is a typical example of market-related news as it is presented in the financial press. I do not mean to criticize the Wall Street Journal specifically for it is arguably the world's premier financial newspaper. The journalists who write such articles are not paid to forecast but to report the news. That, of course, includes street gossip. I am merely stressing that you should not take these articles literally and use them as a basis for making investment decisions because the price movement has normally taken place by the time they are published. Think of it this way: There is no story until the price moves, but the price movement itself creates the need for a story because it has to be rationalized. When you think about it, newspaper reporting of this nature is really a sophisticated and widely disseminated form of gossip featuring off-the-cuff opinions and rumors. A principal difference between media-promulgated and regular gossip is that the former carries the aura of authority and is therefore more believable.
Don't Take Action Based on Tips or Rumors
One of the investor's most useful pieces of information is the certain knowledge that market prices are determined by the mental attitude of market participants to emerging underlying business conditions. In his excellent book Psychology of the Stock Market G. C. Selden devoted a whole chapter to the concept of "they." "They" are familiar to anyone who has talked to brokers or other people who earn their living from the financial markets. Typical comments are "They are going to take the stock up this week," or "They have sold off the bonds." It is clearly not possible to identify who "they" are because "they" effectively means all other market participants.
Most investors at one time or another have bought stocks or other financial assets on the basis of tips provided by brokers or other "informed" sources. The opportunity to purchase something based on "exclusive" information is always very appealing. Unfortunately, such transactions almost invariably end in disaster, although that is obviously never the expectation at the outset. For good reason, hot tips are rarely profitable. If you are the recipient of one, you buy the stock based on the assumption that this is a closely guarded secret. In most instances, however, you can be fairly certain that quite a few other people know about the impending development so it has probably been discounted already. Another reason may be that the information contained in the tip is erroneous. Finally, the information may be quite legitimate but not as significant as you might think. For example, you may learn that Company A has just developed a new device for making widgets. On the surface, this may sound like a breakthrough, in reality, however, the market may know of other companies in a similar stage of widget development making your tip somewhat less than exciting.
Another form of tip is the broker-sponsored advertisement for a company that, it is claimed, has a bright future. The copy may be very convincing, but you should consider that the broker typically has a vested interest in seeing the security rise in price. Perhaps the brokerage firm is making a market in the shares, in which case it will be carrying an inventory of the stock. If the price falls, the firm loses money, but if it rises, the inventory can be sold at a healthy profit.
Sometimes such advertisements take the form of promoting a particular asset category or specific commodity, such as gold or silver. In this instance, the broker gains from commissions generated through any resulting transactions. This type of advertising appears all the time, and it is not particularly helpful from an analytical point of view. However, it can be extremely instructive when the same item is advertised by several sources at the same time. Usually, the advertisement will make the basic argument claiming that there is a threat to the potential supply of the commodity and thus there is good reason to expect demand to increase. Precious metals are often advertised in this way. The point here is that if everyone is advertising the "story" on silver then the reason for buying it is well known. An old adage on Wall Street says, "A bull market argument that is known is understood." In other words, if all market participants are aware of the potentially good news, it has already been factored into the price. After all, if you know that the price will be influenced by some positive factors down the road, doesn't it make sense to buy before the news becomes reality? If you sit back and wait, someone else will learn the story and surely get there before you.
These advertised stories are usually believable because they typically occur over a background of rapidly rising prices. This euphoric market condition is, of course, a result of the rapid dissemination of the bullish news. Be wary of any broker advertisements that promote a specific market or financial asset, especially if the advertisement is sympathetic to the prevailing trend which has been underway for some time and is appearing from a number of different sources.
Having said all that, there are some examples of broker advertisements for issues that have ultimately proved to be profitable. For example, a Merrill-Lynch campaign promoted bonds in the dark days of 1981 (see Figure 3-2). The advice was a few weeks premature, but anyone purchasing bonds would have done very well over the next few years. The same effect occurred following a similar campaign by Shearson in early 1982. This was also premature since prices did not reach their lows until the summer (Figure 3-3). Even so, the long-term investor would have profited handsomely since the U.S. equity market was just about to begin one of the largest bull runs in history.
Figure 3-2 U.S. Treasury Long-Term Government Bond Prices 1981. Source: Pring Market Review.
The concepts behind these campaigns and the one described earlier for the silver market are quite different. The first one is concerned with quick profits and catches the excitement of the moment. On the other hand, the bullish Merrill-Lynch and Shearson advertisements emerged when prices were falling and went against the prevailing trend. They reflect two bullish characteristics. First, it is a response by the marketing people who are trying desperately hard to generate more commissions, which have declined as a result of the bear market. Second, values have slipped to bargain basement levels, an important story that the research departments want to broadcast. The research people are prepared to put their necks on the line because they believe strongly that the market in question is forming a major bottom. By definition, such a campaign must take place after a long price decline when the environment is one of doom and gloom. Disappointing and frustrating whipsaw rallies will have interrupted the bear-market period so that the last thing most investors want to do is buy the particular asset in question. Such advertisements therefore represent a good sign that the market is bottoming even though the timing might be out by a few months.
Figure 3-3 S&P Composite 1981-1983. Source: Pring Market Review.
The Cult of the Guru*
A guru is a market prognosticator who has earned his fame by calling every important turn in a specific market. The reputation of a guru builds up after a number of years of market calls that the investment community perceives to be correct. Sometimes the track record is not all that is claimed; it is the perception of seeming invincibility that is important. During this period, the guru is building a base of followers who are anxious to spread the word. People love to relate tales of market success; setbacks, however, they keep to themselves. At some point, the reputation of the market expert really takes off, and he becomes famous throughout the financial community. This often occurs as a direct result of some article or unusual publicity of a timely market call. From this point on, all eyes are on the guru as market participants and the media wait f
or his every word. Even rumors of a change of opinion that are later denied can influence prices. The media always need to justify price movements with a logical reason so the guru presents them with a perfect rationale. The mutual respect of the guru and the media initially proceeds to a perfect honeymoon. For his part, the guru is hungry for publicity to promote his following and to perpetuate the myth. By the same token, the media are constantly searching for a story or a new angle to sell more copies or improve the Nielsen ratings. What better vehicle than a stock market guru who can tie in the human angle with the price-movement rationalization?
The fallacy of the whole guru concept is that it is not possible for one person to consistently call every important twist and turn in the market. Gurus are human like the rest of us. Their marketcalling ability moves in cycles, just like the achievements of athletes. For a while they are very hot, but later their ability to call markets becomes questionable. Typically, when a person graduates to guru status, he has already experienced a long period of success. Consequently, the "spotlight" period is normally quite brief as the inevitable period of disastrous forecasting begins.
Another factor, overconfidence, is also at work. This is caused by a combination of "brilliant" market calls and the widespread publicity and adulation that the guru has received. The two feed on each other and give him a false sense of invincibility. Joe Granville, the stock market guru of the late 1970s, reportedly said, "I will never make another mistake again." Of course he did, and some of his mistakes were monumental. Unfortunately, gurus, however talented, become accustomed to their own success and get carried away by the adulation. The marriage between guru and follower then turns into a bitter relationship. The follower does not question the guru's prognostications, and the guru-believing himself to be infallible-is careless and arrogant. The follower loses money solely because he fails to think for himself, and the guru in his turn suffers a decline in reputation. Reputation is important in the financial community. It takes many years to build up, but it can be lost in the time it takes to make just one market call. Moreover, a sufficient number of insecure people in the investment business regard the rise of the guru with incredulity and jealousy. These people, who may well have been proved wrong by the guru in the recent past, now seize the moment to pounce, going for the jugular at the first hint of blood.
Investment Psychology Explained Page 6