As Robert Hagstrom described in 'The Warren Buffett Way', there are few aspects of human existence that are more emotion-laden than our relationship with money. So while much of this world revolves around money and most of us are owned by money...we are never satisfied with what we have. In fact, money, like the law, is a cruel taskmaster - demanding all our effort, consuming our thoughts and stealing our dreams.
And the two emotions that drive our money-related decisions most profoundly are 'fear' and 'greed'. Motivated by fear or greed, or both, we frequently buy or sell stocks at foolish prices, far above or below a company's intrinsic value.
To put it in simple words, our emotions have a more pronounced impact on stock prices than a company's fundamentals. And you must agree to the fact that much of what drives our decision about stock purchases can be explained by our own behaviour.
And since the market is, by definition, the collective decisions made by stock purchasers like us, it is not an exaggeration to say that our psychology pushes and pulls the entire market.
| Data Source: Trend
Yes you read that right - markets are but an extension of our collective psychologies.
So if you hope to participate profitably in the market, you must allow for the impact of emotion.
And how can you do that?
- By keeping your own emotions under control as much as possible, and...
- By being alert for those times when other investors' emotion-driven decisions present you with a golden opportunity.
See, we might make it sound very easy when we say that you just need to control your emotions while making stock investment decisions. But is that really so easy when you put it to actions?
Not at all, we must say!
We humans are generally not hard-wired to practice discipline in our dealings with money. If we were, the market would have been a dry place with no real opportunities to make tremendous wealth.
Whatever the experts on business channels say, you need to realise that the market is a highly inefficient place to be in. Stocks that you buy and sell are the same that are sold and bought by someone else. In this case, either you have the correct information about the stock and are subsequently buying or selling it, or the other guy is better placed than you to be selling or buying the same stock.
In simple words, what we mean to say is that when the market provides us with the right kind of opportunities, rather than acting on our own discretion, judgement, and knowledge, we often tend to do what others are doing.
We tend to follow the herd...and so do our stock market returns...and even in the long run, we end up earning just as much everyone else has earned.
So where is the advantage?
How do you find and act upon those wealth creation opportunities that others will realise later and by then you would have made your buck...safely?
The answer, we must tell you again, lies in you having full control of your emotions and investing in the right kind of stocks with utmost discipline.
At Equitymaster, we try and do exactly this while looking for long term opportunities for our subscribers.
We keep emotions out of the picture while researching companies and valuing their stocks.
And the way we do it by following the sound philosophies of investing legends like Warren Buffett and Benjamin Graham as closely as possible. We though try to suit these learnings to the Indian market conditions, where company disclosures are not so good, and the markets are not so deep and broad for us to find 'world-class' companies.
As such, we believe in recommending 'good' companies when their stocks are available at attractive valuations as compared to their intrinsic values. Thus, when intrinsic values of fundamentally sound companies do not change but their stock prices come off by 10%-12%, there is only one thing you as an investor should do - take advantage of the irrationality that is prevalent.
After all, as Warren Buffett would confirm, great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause stocks to be misappraised.