Intro

Our emotions come and go with us every day, but investing really brings out their raw power. Greed and fear have an influence over us that is less than obvious until we see our stocks soaring or dropping seemingly with no end. It makes us doubt our original assessments, or convinces us of our superior stock picking skills. While excitement and a pounding heartbeat are sensations of life to be relished, when it comes to investing, unfortunately it can work against us. To be honest, no matter how much perspective we provide you, the only way to learn from your mistakes is to have real money on the line and feel the emotions. We recommend starting out with smaller investments to gauge your emotional responses.

Have a Plan

Forming a trading plan is one way to minimize the impact of excessive emotional reactions to market developments. Although setting specific price targets on the upside and downside are somewhat arbitrary since market conditions can change, we can formulate plans from the point of view of an investment thesis.

When we form an investment thesis, there are probably a few key drivers for us taking a specific view on a stock. This might be a valuation thesis in terms of financial metrics, a view on how management will do in the future, or a view on industry and competitor dynamics that might help or hurt a stock. Whatever we think is the driver behind an investment thesis is key to forming a plan. A example of a plan we might formulate is one that focuses on our investment thesis. We will plan to reassess the situation and ask ourselves from time to time:

1. Is our original investment thesis still intact?
2. Has anything fundamentally changed about the stock, industry, or economy that might influence our investment thesis?
3. Even if we are right in the long run, are we prepared to be wrong in the short run?
4. What level of risk are we prepared to take?

When It Goes Wrong

Even the best investors get it wrong from time to time. This is inevitable since investing is not a perfectly rational endeavor - it is subject to the whims and psychology of countless investors all acting their own way. When something does go wrong, we will be face with three choices:

1. Do nothing - we might choose to do nothing if we think not much has changed, but we do not believe we should take on additional risk.
2. Unwind our position - we might unwind some or all of our position because we see that the factors supporting our original investment thesis are no longer there, or we have reached a risk level we can no longer tolerate. However in assessing the situation, we also have to keep in mind that more risk equals more opportunity.
3. Add to our position - we might choose to add more to our position if we believe that nothing has changed about our original investment thesis, we have strong conviction, and this is just an opportunity to get even better returns.

Discipline and Self-Checks

One of the hardest things in investing is maintaining discipline. Those who are activist investors who do their own research inevitably has some degree of do-it-yourself attitude and self confidence. This self-belief, while most of the time is a virtue, can become troublesome if not handled wisely. There is always a tendency to “wait out” a rough period when we have faith in our investment theses, but there are times when we need to recognize the wisdom of cutting our losses. Identifying the right times to bail is a tough task, and goes back to having a trading plan. Below is a photo of discipline back in the day.

However, having a trading plan is only useful if we have the discipline to consistently reassess and re-evaluate the situation instead of blindly following our initial conviction. We are never perfect in our discipline, but we need to be perfect when the time comes to make the most important decisions. It is a good habit to self-reflect and ask ourselves, are we going about the process in a disciplined, reasonable manner? No one can tell us exactly what to do because every investment situation, everyone’s financial situation and risk tolerance is unique. We have to have the determination to constantly improve our investing method, admit when we are wrong, and maintain a flexibility to adapt to a variety of challenging situations.

Warren Buffet Quotes

With any endeavor, it helps to have a little help along the way. One of the most admired investors in the finance industry, Warren Buffett has what many agree as the most successful, consistent, and respected investing track record out there. He advocates sound, repeatable advice that is valuable in the long run. Below, we have included a few of his quotes that we deem as extremely useful for investors. Some of these might at first sound a bit surface-level and too simple to be useful. However, we have to keep in mind, that even investment professionals, in the midst of their day to day worries, forget about these basic ideas.

1. “The first rule of investment is don’t lose. And the second rule of investment is don’t forget the first rule. And that’s all the rules there are.”
2. “If you buy things for far below what they’re worth, and you buy a group of them, you basically don’t lose money.”
3. “I would rather value a stock or a business first and not even know the price so that I’m not influenced by the price in establishing my valuations.”
4. “If I were on Wall Street I’d probably be a lot poorer. You get overstimulated on Wall Street. You may shorten your focus and a short focus is not conducive to long profits. The less static there is… the better off you are.”
5. “It’s a temperamental quality, not an intellectual quality [that makes for a good investment manager]. You don’t need tons of IQ in this business.”

Review

Managing our emotions are an important step to investing in a more consistent and repeatable way. It helps us not only improve how we manage our personal finances, but it also allows us to achieve a better understanding of our personal tendencies and character traits. Now that we have covered the investor’s perspective, in the next lesson, we will discuss how market sentiment and stock sentiment affects investment decisions.