The longer I trade and invest, the more I am convinced that the emotional aspects of investing are not merely an offshoot of successful investing. Instead, they are primary.
Emotion rules the markets, and investors should monitor closely both their own emotional states and their perceptions of the emotional tone of the markets. In essence, emotions are information, and in an sea of information of various types and value, emotions can often serve as the most reliable information.
In this vein, I had the pleasure recently of re-reading Tom Basso’s wonderful short book, Panic-Proof Investing (1994). For those who don’t know, Basso has participated in the markets as an investor since the 1960s when, as a child, he would invest the earnings from his paper route in a mutual fund. After training as an engineer, Basso started his own fund based on trend-following principles and methods and became highly successful. His profile and interview in The New Market Wizards (1994) is worth reading closely. Jack Schwager, the editor of the excellent Market Wizards series, dubbed Basso “Mr. Serenity,” given Basso’s calm emotional state. Since his retirement and long before, Basso has ben an invaluable teacher of the markets and how to interact with them as an investor.
In Panic-Proof Investing, Basso stresses the value of maintaining a balanced emotional state when investing. When investor emotions reach an extreme, most commonly in fear/panic or greed/exuberance, investors are much less likely to make good decisions. Certainly, since the inception of the COVID pandemic, the markets have taken investors on a wild emotional ride, from the 30%+ selloff in February/March 2020, to the tremendous rally off the bottom shortly thereafter, to the crushing bear market in 2022 once the Fed began hiking the federal funds rate aggressively, to the bottom in October 2022, including the current powerful rally off the dip in October 2023.
The markets will always test investors emotionally. I see the issue in my advisory practice frequently. Often when clients of Stillpoint either reduce the value of their accounts, or divest completely, the markets are at or near a bottom. By contrast, when new clients invest, or when existing clients increase their investments, the markets may be near a top. Obviously, this does not occur in every instance, and most clients of Stillpoint are very clever about their investment decisions, but these patterns are unmistakable.
It’s worth pointing out that making financial decisions when in an unbalanced emotional state can lead to disaster. This is precisely how financial scammers operate. In part, they succeed by inducing a state of panic in their victims. In case you might be thinking, “It can’t happen to me,” it happens much more commonly than we might like to admit. Indeed a financial journalist was recently scammed into handing over a package to a fraudster containing $50,000 in cash.
How can investors maintain a balanced emotional state? Basso offers one answer, and that answer is both cognitive and imaginative. Whenever Basso feels that his emotional state has become unbalanced, he visualizes himself from a distance, sitting at his desk, monitoring the markets and making trades. Performing this exercise enables him to take a mental step back from the emotions to defuse them and bring context and distance to the circumstances. In that way, Basso will not act on impulse to gratify a pressing emotional need.
I take a different approach. For me, emotions are more difficult from which to distance myself than they are for Basso. What I do instead is to do my best to observe the emotion itself and to observe myself feeling the emotion in the moment. But I also attempt to contextualize the emotion with the memory of similar emotions that the markets have induced in me in the past. My emotional memory in this regard can reach back decades. For instance, I remember many of the extreme emotions I felt in 2008, which also happened to be the year my first client had hired me. I remember the exuberant extinction event the commodities markets experienced in the summer of 2008, as well as the crushing selloff in equities just a few months later. In this way, the more bull and bear markets I have seen, the more easily I can literally feel my way through responding to the markets in a balanced emotional state.
For instance, the current emotion that risks overwhelming me now is greed/exuberance, the false assumption that market conditions will be as good as they are for a lot longer. But it was just sixteen months ago, in the depths of the recent bear market, when my emotions were very different. At the time, instead of mourning the loss of the good times, I tried to imagine the good times to come, and they certainly have arrived. I also haven’t felt this way since 2021. Remembering, and feeling, these different scenarios can bring balance to my emotional state.
Of course, another way to bring balance to an investor’s emotional state is to invest with a rules-based approach grounded in investment principles that have been validated over vast swaths of data. In this respect, it’s no accident that momentum and trend-following investing, the same kind of investing that Basso and I utilize, can itself make managing emotional states easier. Without such an approach, an investor is often swayed from one extreme to another emotionally, which typically brings about poor decision making.
Having said that, I think we are early in the stages of this new bull market, most obviously because I am not yet seeing a rush of investors yet who want to become new clients of Stillpoint. Even traders I know who have traded for decades have had trouble adjusting to and accepting the new bull market, as they continually expect a crash that never seems to arrive. So, if you are considering becoming a new client of Stillpoint, now is not a bad time.
What is your way of maintaining a balanced emotional state? Do you use emotions as information, too?