You're Not as Smart as You Think You Are: Psychotherapy for Cyclical Bull Markets

Our emotions are our biggest enemy, at least when it comes to investing. We should all know this. If you don’t, stop making your own investment decisions right now.

Our emotions lead us to do the opposite of what we should be doing. They lead us to buy high and sell low. They make us excited when we should be scared, and scared when we should be excited. They make us slaves to the stock market; they let the market become our master.

The market is there to serve us, and not the other way around. It is okay to have emotions; we’re human, after all. But what we really need is an investment process. This is system of rules that we follow that keeps emotion in check.

Now, I hate republishing old articles. But a few, the ones that focus on the process, I’ll recycle (and improve upon) for a long, long time. I wrote the following article, in 2007. I included it in my book. I’ve shared it with readers in the past. And I even wrote the flip side of it in October 2008, addressing the impact of a cyclical bear market on out psyche by cyclical bear market.

I’m not offering it now to provide a hidden message that I think the current (cyclical) bull market is over. I don’t know that. I just want to remind you (and me) that a rising market has an impact on our psyche, our analysis and our decisions, and we need to be aware of it.

You are not as smart as you think you are;
psychotherapy for (cyclical) bull markets

Lately I’ve been getting this powerful feeling that everything I touch turns to gold. Every time I buy a stock, it goes up. Did I finally figure out the stock market game? Did I find a secret way to follow Will Rogers’ advice: Buy stocks that go up, and if they don’t go up, don’t buy them.

No, I didn’t get much smarter, and my stock-picking skills haven’t improved that much over the past year. I was simply a willing participant in the latest (cyclical) bull market. A bull market makes you feel smarter than you are the same way a bear market makes you feel dumber than you are.

Feeling smart makes you do the opposite of what you should be doing. The euphoria of the golden touch is a dangerous thing because it can make us careless. We forget about risk since we haven’t seen it in a while and focus only on the rewards. You have to actively make yourself aware of the four-letter word R-I-S-K!

How do you do that? My favorite way is to remind myself how dumb I am. I pull out an annual return report of a company on which I lost a boatload of money and masochistically try to read it from cover to cover, reliving my errors.

We all have these stocks, the ones we lost a lot of money in because we were overconfident. We tend to forget about them during a bull market. But I suggest you remember them now, so you’ll have fewer of those names to remember in the future. Risk is still there; it is just hiding under the joyful sentiment of the bull market.

Believe me, it will show its ugly face. It is just a matter of time.

Discipline counts

In a bull market, it is easy to forget about selling discipline and then turn into a “buy and forget to sell” investor. Every time you sell a stock, you look dumb because it usually goes up afterward.

I recently sold several stocks, shamelessly, paying absolutely no attention to the fact that after I sold, they went higher. I don’t feel smart about that decision. However, when I bought those stocks, I set valuation targets. When they approached the targets, I quickly reviewed their fundamentals. They had not changed much. The decision was obvious — sell.

Cyclical bull markets teach us not to sell, while cyclical bear markets teach us not to buy. If you let the market tell you what to do, you have no process.

But the bell doesn’t ring when bull or bear markets are over.

You cannot worry about marking the “top” in every sell. My objective is not to buy at the “bottom” and sell at the “top.” My objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.

Comments

[Graham and ...:]

I, at least, blow "hot and cold" in cycles, depending on the market. "Everything I touch turns to gold" was the feeling of the past quarter or so. But the hot streak ends. And you have to be aware of its ending to take money off the table.

Jun 15 02:43 PM

[Larry House:]

All true but so much easier said than done.

Jun 15 05:08 PM

[Crudeman:]

As Bernard Baruch said....He didn't buy at the very bottom or sell at the very top. He just kept that big portion in the middle!

Jun 15 05:44 PM

[untrusting ...:]

True, but then Bernard Baruch was one of the choosen few in his day who had access to "inside and critical information" that most of us peons do not have.


On Jun 15 05:44 PM Crudeman wrote:

> As Bernard Baruch said....He didn't buy at the very bottom or sell
> at the very top. He just kept that big portion in the middle!

Jun 16 12:49 AM

[TWS Investm...:]

Right, the goal of investing is to make money, not to make the whole move. So many traders forget this obvious point...

Jun 16 08:46 AM

[Alphameister:]

The market humbles us all some of the time. And we master it only when we can look objectively at indicators that have worked well over the course of time. Every time I have been humbled by the market it's been when I convinced myself that I knew better than the market. Thanks for a reminder that can never be repeated too often.

Jun 16 12:59 PM

[dsrtwriter:]

This article should definitely be repeated once in a while to remind us.

The problem we have is our aversion to failure, and that more often than not, creates failure, which reinforces the aversion.

The market goes up, we take profits, and it continues to rise, and we believe we are stupid, that we have failed.So next time, we "hold and forget to sell". In fact we tend to ignore further rises, as they still don't "tell" us when to sell.

Conversely, stocks drop, and we "buy on the dip", but the stocks drop further. We feel stupid, so next time they drop, we sell what we have and park in cash, while stocks drop further and yet we do not buy. Finally, the stocks rise back up to our sell price, and rise past it. We panick, buy back in, and then the stocks drop again.

This last year was a woodshed lesson for the "buy on the dip" crowd. But by the time Dow was down to 6500 range, we were so burned that we were too scared to buy. Too scared to buy then, but not at 8500.

Then the market roars back to the mid 8000s, and we are too scared to stay in cash. Whipsaw again.

We are always battling our human nature, so repeats of the above lesson are so important to even the professional investor.

Jun 16 05:33 PM

[Subhankar:]

The discipline of selling a little early and buying a little late - the 'Holy Grail' of wealth creation - is easy in theory but difficult to practice!

Jun 17 02:30 AM

[Fred Voetsch:]

Excellent.

This is why I listen to three (more, actually) very wise, older people with varying methods for valuing the markets: Richard Russell; Gene Inger; Tim Wood.

If I can show the discipline to listen to them instead of my emotions I do very well. BTW, my emotions were starting to give in to this rally but guess what the three wise men are all saying?

Jun 17 03:49 AM