Title: Aktienpsychologie (Shares psychology)

Author: Max Mittelstaedt

Hi all,

while I was in the zone of reading about stocks from another stock broker in my previous post, I took the next book that would teach me about the human psychology in stock business.

In the previous review I noted that if you had the four G’s (Geld, Gedanken, Geduld, Glueck) this would determine whether you are a die-hard speculator or shaky speculator. Whether you have long-term success or incur losses is dependent how you act in different stages on the stock exchange.

Generally, when a private company is acquired by another company, the acquirer will do a due diligence on the company’s current position and future potential. After all this they will have their calculation of what they think the company is worth, and make an offer to buy. If different companies come in and do their own due diligence, they will most likely all come up with a different value since they consider factors differently. However, it is not likely that they would necessarily have vastly different valuations.

• The example above constitutes calculating a value of a company based on its future earning potential

However, what happens on the stock exchange is far from the fair value of the company. Many look at the curve the company is currently taking, and if they believe that it can grow further, they might buy in as well. Others hear some news extract, see that this could bring more revenue in future, and therefore might consider to jump in as well. Even when the P/E Ratio is becoming unrealistically high and out of proportion, some people still jump on. This is all driven by the psychology of the masses, ie. following the pack.

This is what every stock investor should be careful about, and this is where we bring in the context of the book.

To get the true value of a company one will need to do some research about the company, as well as the current situation in the city and country, and world economy to identify any trends that are going on, and how the company fits in to that picture. Therefore, the investor should calculate their own expectation of what they determine the true value to be of a company, and then look at the market price of the shares to determine if the market players have overvalued the stock price or not.

• What investors should not is that when the company sold its initial shares to the market, they received a fixed amount of money from that issue. Using this money they would try and grow.
• The subsequent price found on the stock exchange is solely the price of the shares traded between investors. Thus, if the company has plans to expand, buying some of their shares doesn’t result in money flowing to the company, so they can use those funds to expand, but it only flows to another seller.
• Therefore, when a company’s stock price is overvalued (ie. the price you pay for one shares is significantly higher than what the company currently earns, which results in you having to wait a very long time to recover your invested amount) it is mostly when it is not recommended to jump in, but many people still do, because of the hype going on all around

Tip 1 – Make your buy and sell decisions in an environment where you are not influenced by the hype of the market

Another factor that influences whether/what we want to buy or sell, is the current mood we are in. For instance, if you have seen many stocks plummet, you might be inclined to think you should sell too, to minimize your losses. On the other side, if you had a good day, and you see a stock is on the rise, you might be inclined to buy, hoping it will just go higher.

Tip 2 – Don’t let your current mood influence your decision to buy or sell, but rather stick to your strategy, and cancel out all the noise.

Another psychological phenomenon we experience is loss aversion. Here, it states that the feelings we have when we lose something we owned is greater than when we gain something we didn’t have before. The emotions we attach to the different phases are stronger in the loss situation.

Since we have this holding us back, we might wish to sell off our investments when things are going through a rough time, and cut our losses, rather than sit through tough times. This is where you need to stay calm and stick to your strategy. If you did a good and thorough job of picking a good company, and due to the economic situation your company (along with others in the economy) is suffering) you are thinking of selling, you should first consider if the price is dropping because the company is worth less, or whether people are just selling off to get liquidity.

Tip 3 – Don’t make hasty decisions just because things are going bad around you.

Passive investing refers to the action of an investor making an investment, and not actively following its movements on a day-to-day/week-to-week/month-to-month basis. Even though this is important, since the investor wins in the long run, we shouldn’t be oblivious that a company might become bad. Therefore, every year one should go through their portfolio, and see whether you would buy that share again, or whether you don’t have faith that the company will do good in the future.

Tip 4 – Reevaluate your investments for their future potential

Recognition heuristic is another psychological phenomenon we should look out for. When you recognize a company, and they are large and you have an idea of what they are doing, then assume they are good. Picking something that you are familiar with, but not necessarily doing the research to consider if they really are good, or will still be good in the future.

An example of this includes companies included in the index, a representative marker of the strongest and largest businesses of the country. If you are out to earn dividends, then these companies are some of those you could go for, but if you want to invest for growth in value, then you might need to consider a few others as well, as there are some that still have strong growth potential since they are still small/medium-sized.

Tip 5 – Don’t fall for the recognition heuristic

Since there is a hype going on in the economy at regular intervals, we might just be easily tempted to buy in. However, many investors advise against hype stocks, as they tend to be overvalued, and many investors who get caught up in the hype will become losers. Therefore, the top advice to ensure you will act soundly is to write down your investment strategy, and stick with it. Then, when a new hype comes around, you will more likely stick to your guns, and not make a potential loss-investment.

Tip 6 – Develop your strategy before you invest, and then stick to it

Another favourite bias is the anchor bias. We apply this when we use something against which we measure everything else. Therefore, if you use the price of one company’s share price of one particular day, and the price drops you might think that it has now become much fairer valued, due to people selling off. However, the problem with this is where you set the anchor. If you set the anchor at a price that is still overvalued, then you are bound to lose as well when another big loss comes around. Therefore, when you set your anchor, make sure the price is a good reflection of the true potential of the company.

In the “Intelligent Investor” the terms applied by the author for this approach is ‘Margin of Safety’ , which means that they value investor calculates the true value of the company, then calculates the value below that price at which they will buy the stock, and then wait for the price to reach this amount.

Tip 7 – Calculate your price at which you will buy in, and calculate that based on the true company price

Become an anti-cyclical investor. This means not falling for the hype, but buying when people are selling off, at the price you are happy to become a share owner of the company. Since we are social animals, it is difficult to act contrary to how everyone else is acting. However, sometimes people over-estimate a situation and then sell off just to avoid making a too large loss.

Tip 8 – Become an anti-cyclical investor

When you made a mistake, you might think to do something to recoup that loss, and maybe act even more irrational, by becoming more speculative. However, this is not advisable, since not many make much money from speculation. Therefore, the important thing is for the investor is to accept that they made a mistake, and look at their strategy to make better decisions in the future.

Tip 9 – Never try and recoup your losses

There are a lot of companies that are listed on different stock exchanges around the world, which makes it difficult to choose a/more companies that you would like to be invested in. One might be tempted to buy many so that one is properly diversified. However, the idea should be to own as many companies that you would keep track of their results, and therefore keep your portfolio limited to a certain small amount of companies. By keeping it small, you have the opportunity to properly analyze the different companies’ results and future prospects. Whereas, if you spread your portfolio over too many companies, you might become overwhelmed, and not keep track of them at all.

Tip 10 – Spread your portfolio over a manageable size of companies, so you can keep track of them, and generate the greatest returns from them.

Summary:

As you would have picked up from my past reviews, the authors always stress the importance of getting your head first in the game, before actually playing. This book has listed some of the errors that we as humans tend to make when we are new to this game and don’t follow the advice from experienced investors. The book gives some tips, but mostly includes references to paragraphs and phrases from other people’s books, than the author’s own experience. For this reason the book will only be rated 3/5

I hope you learnt a lot and learn a lot more as you delve deeper and read more on investing, so you refine your investment strategy that fits your style.

All the best!!!