Red Pine on avoiding upside-down investing behavior
By the Andersens
Investing success is more likely when we remember the old adage – ‘buy low, sell high.’
Most people love buying their favorite goods such as food, clothes and cars on sale. But when investing, they don’t think or act like value shoppers.
Ben Graham: Even though investors know they’re supposed to buy low and sell high, they often get it backwards. Ignoring the emotional whirlwinds of the markets is critical.
When market prices are rising sharply, most investors want to buy, ignoring real-world values, and when prices are falling sharply, they want to sell – also ignoring values.
We call this upside-down behavior.
Why do investors time and again buy when they should sell, and sell when they should buy?
Emotions take over! Price increases are exciting; price declines can be scary.
- There is a tendency to become more and more optimistic [greed] as stock prices rise higher and higher, even though risk is likely increasing as businesses typically become overvalued.
- There’s also a tendency to become more and more pessimistic [fear] as stock prices fall lower and lower, even though risk is likely decreasing as businesses typically become undervalued.
It is human nature to extrapolate the recent past into the future – people get fooled by this over and over. It’s also human nature to ‘follow the crowd,’ but it’s often the wrong thing to do.
The power of herd psychology is nearly irresistible, making it essential that as investors we learn to resist its temptation.
Contrarian thinking can be a remedy – it says:
- Keep your wits about you when others are losing theirs.
- Be opportunistic when most investors are pessimistic, and bargains are around you everywhere.
- Be prudent and selective when most investors are optimistic, and risk is around you everywhere.
Don’t give in to herd instinct or to your emotions. Think and act rationally.