Sunday, August 07, 2005

Emotional Discipline & ‘sell’ decision

The other day I was thinking to myself ‘What makes a successful investor?’ I found a clue in the words of Warren Buffett “Only when you combine sound intellectual with emotional discipline, you get rational behavior”. The emotional discipline, I feel, determines if a man with sound intellectual is successful or not.

Now I wanted to answer, “What is this emotional discipline?” One thing was for sure that it dealt with dealing with ones intuitive responses to the various unpredictable situations. Does this mean that we have no control over that faculty? I, rather, concluded that the problem lies in the fact that not many people are able to recognize the problem rather than not being able to solve it. Recognizing this problem can help one control this faculty.

If so how should, I as an investor, go about recognizing this problem or becoming more emotionally disciplined? I divided the whole process in 2 parts:

(i) Emotional discipline and ‘Buy’ decision
(ii) Emotional discipline and ‘sell’ decision

I also feel that the “emotional discipline and ‘sell’ decision” is much more important to comprehend. Because once we buy a security we develop various types of subconscious attachment to our earlier decision. We develop a desire to prove ourself right.

Warren Buffett said, “Being a reasonable creature, human beings can rationalize anything they set themselves upon”

I also recognize that once we can see that we are developing that kind of attitude we can deal with the problem. But it is much easier said than done. All I can think of now is recall Ben Graham’s word, “The worst enemy of an investor is he himself”

Ben Graham is absolutely right but leaving it that way will be like faking the reality. We should rather use this knowledge to find support towards helping out ourselves.

Now I thought of the possible attitudes an investor can develop after committing himself to a particular stock. I was able to think of 2 possible attitudes (or) syndromes. And I would call them as:

(i) Hail me syndrome
(ii) Masochist syndrome

Hail me Syndrome:
This leaves an investor with a burning desire to prove himself correct to ‘himself’, primarily. This he does by convincing others that he is right in committing himself to a particular stock. He starts to discount all the good news and say that he foresaw this and that (in hindsight, of course). What about the bad news? He goes about finding counter evidence (real or unreal) to a seemingly real problem.

In its extremity, this syndrome can be similar to a patient who has cancer but does not accept it until he faces Mr. Yamdoot.

Masochist Syndrome:
When somebody is suffering from this syndrome he is too self-critical and worries a lot about all the bad things that might happen (he does not see things in terms of probability). Also he does not speak about his commitment in public fearing reproach. What about good news? He sleeps well for a night or two.

In its extremity, the investor decides to give in that he was wrong and get rid of the commitment on any of the minor dips caused by speculative drive.

How to deal?

Which syndrome is bad among the two is not the question. Both the syndromes in their extremity cause severe loss. Also I think everybody suffers from either of the two syndromes, it is the magnitude that varies.

I think that having recognized this problem is very much the solution in itself. Whenever we conclude that a particular stock is to be sold, we need to answer the following questions

“Am I acting in favor of my financial well being?”
“Am I acting rationally based on facts, rather than illusions?”

The first question requires one to be intellectually sound and second one requires one to be rational. Again the degree of difficulty in answering the above question determines if one is successful investor or not.

As of emotional discipline and ‘buy’ decision I think it very much depends on his perception about his own intellectual and the realistic expectation that he prefers to seek from the commitment. Moreover I have not bought any stock in my life as yet to be able to comprehend this in its entirety. (May be this is an excuse for I have not sold any stock either)

For decades people have spend there lifetimes in trying to understand how the human mind works. I, rather, feel that if we can understand our own mind we will be much better served.

I would like to conclude this write up with Keynes words “It pays to be partially correct than being precisely wrong”.


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