Being greedy when others are fearful is easier said than done. Most investors may say they would do it but few actually practice it.
In the last downturn, how many of us actually had the courage to buy stocks when everyone else was selling? So why is it so hard to act against the grain?
Fundamentals change too
When we think of market downturns, we usually imagine a world where nothing changes except for stock valuations. The reality, however, is nothing like that. Morgan Housel from the Collaborative Fund explains:
“The reason you may embrace ideas and goals you once thought unthinkable during a downturn is because more changes during downturns than just asset prices.”
Take 2008 for example. Stock prices fell hard, but not without reason. The subprime mortgage crisis in the United States developed into a full-blown international banking crisis. Previously sound banks failed, companies went broke and consumer spending plunged.
These are fundamental changes that caused a decline in company earnings, huge layoffs and reduced consumer wealth.
In such times, it is easy to see why investor confidence was sapped.
People need positive reinforcement
Even when we do think differently from the crowd, most of us are not able to act on it. People require positive reinforcement to take action.
For instance, when we are bullish on a stock, we need encouragement from external sources. We seek out positive reinforcement in the mode of brokers’ opinions, analysts reports, or even friend’s approval.
However, in a time when everyone is fearful, positive reinforcement is hard to come by.
Fear is hard to ignore
Emotions also play a huge part in our investment decisions. When we start investing, we often tell ourselves to ignore emotions and to focus on facts. But, unfortunately, it is extremely difficult to tune out emotions completely.
In his book The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy, investor James Montier said, “It turns out there are numerous human traits that push us toward conformity and away from individual thinking.”
He explains that neuroscientists have found that when individuals take the road-less-travelled, they experience fear. Fear is there for a reason. It is a defense mechanism that is built to protect us. Acting against our fears, is thus, innately difficult.
As such, it is no wonder that fear plays a big part in our investing decisions. When the stock market is raging, investors have a fear of missing out (FOMO), while the fear of losing money makes people sell in a bear market.
Contrarian Thinking
“ …don’t be led astray by Wall Street’s fashions, illusions and its constant chase after the fast dollar. Let me emphasize that it does not take genius to be a successful value analyst, what it needs is, first, reasonably good intelligence; second, sound principles of operation; and third, and most important, firmness of character.”
Benjamin Graham
It is not difficult to see why contrarian investing is so challenging. If it were easy, it wouldn’t be called “contrarian” in the first place. But on the other end of the spectrum, simply being contrarian for the sake of it, is also extremely detrimental. We need to seek the right balance.
For us to be a successful contrarian investor, we need three key characteristics: The ability to digest and analyst facts; individual thinking; and the courage to overcome fear. If you master these three traits, you will likely reap the rewards in the future.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.