Newsletter

March 17, 2007

Changing Your Mind Set - Part II

Market & Sector Review
Managing Fear and Greed

Largest Changes In Raw Numbers (21 Days)

This Week's Economic Reports

Changing Your Mind Set - Part II

Many years ago, I was privileged to receive a series of videotapes dealing with the workings of the brain. The video series was a taped presentation to a selected audience and if memory serves me was presented by the Pacific Institute. Their basic premise is simply that there are 3 parts to our minds functioning: The Conscious mind; the Sub-conscious mind: and the Creative Sub-conscious mind.

The conscious part of our mind takes in everything we see, hear, feel, and taste. It then takes that which it considers significant and passes that information to the sub-conscious mind. The sub-conscious mind is where our definition of truth and reality; our belief systems lie. When viewing this series it was the first time I was introduced to the concept of the Creative Sub-conscious. The creative sub-conscious functions to make sure our current beliefs about our world are true! For if they are not true, then we would be by definition insane, would we not? It therefore allows the conscious mind to accept information, which supports our belief system, and reject information, which is contrary to our belief system.

Allow me to give a simple way you may prove the existence of the creative sub-conscious for yourself. At the time of viewing this series I was in the market for a new car. It was to be either a Ford, or a Chevy (at the time foreign makes were virtually non-existent here). After finally deciding on and purchasing the Ford, I immediately began to notice all the new Ford's on the road. I also noticed the occasional Chevy that was broken down on the side of the road. I never noticed these things before, simply because the information was not important and therefore was discarded by my conscious mind. It now became important, as my creative sub-conscious was very busy justifying my decision. Try this experiment for yourself, the next time you decide to make a substantial purchase such as a new car. You will see a change in what you all of a sudden notice around you, that while always there you never took particular notice of before.

Suppose now you buy or short a stock based on what you believe at the moment. If you do not have a strict exit strategy, your creative sub-conscious mind will continue to find reasons to stay with that position, whether those reasons are valid or not is immaterial. You must continue to find reasons to justify your decisions.

Occasionally for fun I visit the Yahoo boards on stocks that I am trading. What I have found particularly interesting over the years is simply this; take a stock that has gone through a substantial decline, now look back at the message boards on this stock. You will find posts that were very bullish at the top which is quite normal, however after a substantial downward spiral, those same posters are still there telling you why the market is wrong. This is the creative sub-conscious at work, continuing to justify their purchase no matter what happens.
Market & Sector Review
Managing Fear and Greed

Since I have noticed recently a good deal of both fear and greed being exhibited by many, this week we'll digress a bit and discuss this very timely subject.

As most long term subscribers are aware I am a fan of "Wall Street Cliché's" that have withstood the test of time. One such cliché befitting this week's newsletter: "Bulls make money, Bears make money, and pigs get slaughtered." How often has each of us at the bottom of bear markets experienced real fear, stomach churning, wondering if we should sell before our portfolio reaches zero? And on the other hand how often have each of us at the top of bull markets experienced euphoria wondering just how much we'll be worth next week and next month, counting our chickens before they hatch?

To the trader and investor alike these emotions can be deadly, causing us to sell at precisely the time we should be buying and buy at precisely the time we should be selling. It is as important to understand the influence of fear and greed upon ourselves and on the financial markets. There are countless books and various courses devoted to this topic. At the bottom of this newsletter I'll provide some interesting and worthwhile links for you're reading and understanding pleasure.

Greed

Most people have a desire to acquire as much wealth as possible and in the shortest amount of time. Personally I believe it's the shortest possible time frame that leads one to greed. An excellent and fairly recent example is the boom in Internet stocks during the late 1990's. Buying activity in Internet-related stocks, reached a fever pitch. Investors got greedy, fueling further greed and leading to securities being grossly overpriced, which created the bubble. It burst in mid-2000 and kept leading indices to the downside through most of 2002. Yale economics professor Robert Schiller coined the term: "irrational exuberance".

A Lesson From Warren Buffett: If nothing else Warren Buffett showed us just how important it is to stick to a plan even during buying frenzies. Buffett was heavily criticized for refusing to invest in high-flying tech stocks. However he stuck with what he was comfortable with: his long-term plan. By avoiding the dominant market emotion of the time - greed - he was able to avoid the losses felt by those hit by the bust.

Fear

Just as the market can become overwhelmed with greed, so it can be overwhelmed by fear. Fear is a strong emotion; it is the anticipation or awareness of danger. Fear is an important human emotion as it can warn of us of impending dangers in which we must act to save ourselves from potential harm. When stocks suffer large losses for a sustained period, we as normal human beings become more fearful of further losses. Being fearful, however, can be just as costly as being too greedy.

Just as greed dominated the market during the dotcom boom, the same can be said of the prevalence of fear at the depths of the bear market that followed. Near the bottom of the bear market many investors in a bid to stave off disaster, moved out of the equity markets in search of less risky buys. Many poured their money into money market securities, stable value funds and principal-protected funds - all low-risk and low-return securities. In fact 2002 saw the largest amount of outflows, about US$40 billion, from the equity markets since 1988, a year after one of the worst stock market crashes in history, and a record $140 billion flowed into the bond market.

Investors threw their plans out the window because they were scared! Brokers that I know were telling me of clients that hadn't opened their statements in months "out of site, out of mind". Refusing to act is an act, it's the act of burying your head in the sand and hoping everything goes away. The markets as measured by some of the major averages have come back to make new highs or are closing in on the highs of 2000. Some who held through the bear market have come out OK. That is provided they were not invested in the previous craze. Many who invested in some of the dotcom bubble stocks as they came public, own stocks in companies now out of business. It was all part of the craziness of the times. While responsible speculation should be part of even a conservative investor's portfolio, it needs to be managed correctly.

Comfort Level

Whether you trade stocks, futures, options or other derivatives, there is volatility involved much of the time. When you lose your comfort level due to a market or a stocks instability you become vulnerable to fear and greed, which often results in very costly mistakes. Avoid getting swept up in the dominant sentiment of the day. You have a plan, or you best devise one, stick to it and avoid these costly emotions and inevitable traps. I'm well aware; this isn't as easy as it sounds. There's a fine line between controlling your emotions and being just plain stubborn.

Conclusion

You are the final decision-maker for your portfolio and thus responsible for any gains or losses. Sticking to sound plan while controlling your emotions and not blindly following someone else's advice is crucial to successful investing and maintaining your long-term strategy.

Some very worthwhile links to delve further into Greed and Fear and how they can affect you and the marketplace: Emotions are critical, learn to manage them or be doomed to repeating mistakes over and over again.

  • How To Control Fear And Greed In Trading
  • Harry Domash 10 investing tips to balance fear and greed - MSN Money
  • Fear and Greed in Financial Markets: A Clinical Study of Day-Traders
    Contributors: ANDREW W. LO - Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER) DMITRY V. REPIN - Massachusetts Institute of Technology (MIT) - Sloan School of Management; Boston University - Department of Cognitive and Neural Systems BRETT N. STEENBARGER - SUNY Upstate Medical University - Department of Psychiatry and Behavioral Sciences
  • Fear and Greed In Markets
    Largest Changes In Raw Numbers (21 Days)

    [ Reserved for supporting members, now posted in members area ]
    This Week's Economic Reports

    Have A Great Week!

    Bill

    Disclaimer: Trading in securities, of any type, may not be suitable for all individuals. The contents of this newsletter are not a solicitation to buy or sell securities. The opinions expressed are solely that of the author. You must do your own research, contact your own financial advisor for suitability of any investments. Data gathered is from sources believed to be reliable, but NO guarantee as to their accuracy is made.