C H A P T E R T W E L V E
SUMMARY AND
have their origin in the teachings and theories of various econ- omists or philosophers, others claim that economic trends are random, unpredictable, and therefore, incapable of being ef- fectively analyzed.
Still others believe that economic salvation is embodied in the virtues of the gold standard or in the seemingly rational policies of a balanced budget. Books, theories, opinions, and advice on this especially relevant subject are plentiful, but little concrete information is available that deals with the emotional aspects of investor behavior. Nor is there a confluence of opinion regard- ing the optimum methodology by which an investor or business- person can implement specific investment strategies without the potentially destructive consequences of emotion, lack of disci- pline, fear, or greed.
For many years, advisors and economists have assumed that investors are reasonable, relatively normal, well-adjusted, non- neurotic, and self-disciplined individuals. Could it be that the op- posite is true? Could so many investors and speculators be losers because they lack the necessary emotional prerequisites for in- vestment success? Certainly, the experience of futures traders pro- vides us with strong evidence that 80 to 90 percent of speculators in these markets tend to lose their starting capital. Could it be that the rate of losers is just as high in the stock market? Perhaps not. Perhaps only 50 percent of stock investors are net losers.
Certainly, the percentage of losers is a direct function of the types of investments that are selected. It appears to me that a num- ber of variables may either exacerbate losses or facilitate profits:
The nonprofessional investor is likely to fare well in longer- term investments as opposed to shorter-term speculation.
The investor who maintains a balanced portfolio is likely to fare better than the investor who puts all of his or her
eggs in one basket. Diversification spreads risk and makes profitable results more likely.
Mutual fund investments appear to be the ideal area for a majority of investors inasmuch as they spread risk, diversify, and practice the discipline necessary for successful investing.
Investors with larger starting capital tend to do better in the long run inasmuch as they can diversify their holdings more quickly than can the individual beginning with lim- ited capital.
The investor who is aware of his or her personal limita- tions, assets, and liabilities tends to fare better than the investor who plunges headlong into the markets without regard for the potential emotional consequences of his or her behavior.
Investors who follow a given plan or strategy tend to be successful more frequently than do those who place their money haphazardly or without regard to a given plan, sys- tem, or strategy.
Those who are capable of selling or selling short as well as buying tend to fare better than those who can trade only from the long side or are always bullish.
The fact that there are still losers in the stock and futures markets tends to negate the value of our purportedly great strides in business science and investment analysis. Computer technol- ogy, modern economic theory, and a veritable watershed of in- vestment messiahs have not been able to make winners out of all of us. Facts and figures do not create investment winners unless they are implemented with discipline, consistency, and organi- zation. I know from personal experience that strategy, theory,
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advice, analysis, trading systems, and investment schemes are only minor aspects of the success equation (although many would disagree with me).
J. Peter Steidlmayer, whose success in futures trading is known to few outside the field, has noted repeatedly that the formula for market profits is dependent on the discipline and emotional maturity of the trader. Although Steidlmayer was not the first to assert the importance of human emotion in the achievement of success, he did so in a concise and easily expressed fashion when he noted the following in Markets and Market Logic (Porcupine Press, 1986):
Man’s powers of observations are no longer crucial to his survival and thus have declined through underuse.
Man’s ability to think for himself analytically has also declined through lack of use. . . .
Man as a class would prefer to be led and told what to do rather than think for himself. . . .
Man as a class is inconsistent in his behavior: he will respond differently to the same situation and set of data depending on mood, stimuli, etc.
Although you may learn more about virtually all fields of investing from the many books available on this subject, you will find an obvious void in the area of investment psychology.
One chapter in this book cannot erase the misconception that better investment methods will automatically lead to success.
I do think that the analyses presented here of human psychol- ogy can provide valuable assistance to those who accept the notion that success does not immediately follow market under- standing, unless it is accompanied by self-understanding and discipline.
A Question of Origin
There are those who contend that human behavior does not determine economic trends, and there are also those who argue in favor of economic determinism. Determinists claim that eco- nomic conditions result in stresses and strains that have a marked effect on human behavior and emotion. Poverty, for example, may breed frustration and aggression. Wealth may breed com- placency and the need for more stimulation, which, in turn, may promote alcoholism or drug dependency as well as anxiety and psychophysiological responses such as ulcers and migraines.
On the other hand, psychologists may argue that emotion influences economic behavior. Their line of reasoning might be stated as follows:
Human emotional responses such as anxiety and stress produce the need for such things as liquor consumption, movie watching, and overindulgence in food. Such activ- ities are compensatory or defensive mechanisms that are inspired by psychological needs. Insecurity, for example, may stimulate certain types of economic behavior, such as the accumulation of material possessions, as a form of compensation. Irrational fear may cause investors to liq- uidate stocks, futures contracts, real estate, collectibles, and the like, thereby causing market crashes. Insatiable greed may stimulate excessive buying of stocks and other investments regardless of price and regardless of poten- tial return.
Each of these positions is deterministic, however. They are unacceptable lines of reasoning. They take an extremely narrow view of humankind. These positions fail to consider the fact that
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human behavior is composed of inputs from all of the senses and virtually every aspect of the environment. Just as emotion and psychology alone cannot be seen as the stimulus of eco- nomic activity, we cannot view economic activity as the sole cause of human behavior and emotion.
Some theorists have claimed that the fundamental basis of economic activity is war. Yet such a narrow interpretation is also faulty. Life, economics, history, and systems are neither simple nor readily relegated to constant causes. Whereas one economic cycle may have been precipitated by a given event or events of specific origin, another cycle may have been precipitated by en- tirely different causes.
Some theorists have claimed that the origin of long-wave cycles rests in technological breakthroughs. I find these asser- tions equally fallacious. In reality, economic and investment be- havior arises from a multiplicity of inputs—some psychological, some economic, some technological, some sociological, some religious, and so forth.
Economic Trends
This is an important area of consideration, because it will likely affect all of your investments, whether in stocks, futures, options, or real estate. Consider some of my random thoughts about history and the big-picture outlook, for you as an investor and for the economy in general.
Instant Gratification
Immediacy reigned supreme in the 1990s and continues today. You can log onto the Internet and within seconds can see
world news; download music and video chips; chat with people you’ve never met; post bulletins in newsgroups; buy books, videos, or CDs for delivery the next day; find a new or used car; and even buy software for immediate downloading. For those who seek to satisfy their sexual desires, no matter what time of day, thousands of porn Web sites are available for instant access at the mere entry of a credit card number.
On the more pragmatic side of things, you can trade stocks online with instant electronic order entry, you can check your bank balance, transfer funds, or donate money to your favorite charity. And if none of this happens fast enough for you with a 56K modem, you can connect using a high-speed connection, a superfast TI line, or a variety of high-speed alternatives. And you can enjoy all of these on your new incredibly fast computer that sports an ultrafast CD-ROM drive with a fast access internal hard drive. Of course, your pleasure and speed of processing can be increased with a few gigabytes of high-speed memory chips and a voice recognition package designed to speed up in- puts. And, of course, you can relax in style as you do all of this on new office furniture you don’t have to make payments on for 12 months and at the low, low rate of 3 percent guaranteed.
Speed has pervaded virtually every aspect of life. Stocks move up and down faster than ever before. News travels across the world instantly via the Internet.