A kind of social outcast in the world of investments

"I have argued that every person is born with an instinct to join social groups and cultivate social bonds with other individuals. Such instincts and social skills endow individuals with an evolutionary advantage. For this reason one expects and observes that people are far more comfortable accepting the conventional wisdom of their social groups and acting in accord with such conventions. This is true of investment crowds no less than of groups that form the larger society in which we all live. Yet a contrarian trader must place himself apart from investment crowds. By choice he becomes a kind of social outcast in the world of investments, the very world to which he has chosen to devote so much time, energy, and money. Few people can comfortably live with this sort of emotional dissonance. And this internal conflict is always felt most acutely when the financial stakes are highest, when the groupthink phenomenon associated with investment crowds is most intense."

A kind of social outcast in the world of investments

Invest in an opposite theme

"Why is it important to understand investment crowds? I have argued that large investment crowds are associated with significant market mistakes, situations in which the price of a stock, bond, or commodity is forced too high or too low relative to its fair value. If this is true, then a speculator can potentially earn above-average returns by exploiting this connection. One need only watch for the emergence of an investment crowd. As the crowd grows, it makes sense to invest in harmony with the crowd’s investment theme. But eventually the crowd grows so large that it forces the market price well past fair value. At this point the investor needs to either step aside from the crowd’s theme investment or even invest in an opposite theme."

Invest in an opposite theme

Every real-life decision is made under conditions of great uncertainty

“When you see a chart accompanying an explanation of a stock market technique, you also generally also see how things turned out. This makes the result of a good investment decision seem inevitable and obvious. But every real-life decision is made under conditions of great uncertainty, at a time when it is not at all obvious whether your choice will yield a subsequent profit or instead yield a loss.

Every real-life decision is made under conditions of great uncertainty

Information cascade

 

“Crowds develop and grow during a communication process called an information cascade. During an information cascade the print and electronic media focus public attention on recent, dramatic movements in markets and the associated profits and losses of investors. This in turn encourages people to put aside their natural skepticism and adopt the investment theme the media are highlighting. As the investment crowd thus grows larger, it pushes the market even further away from fair value and toward a substantial valuation mistake.”

Information cascade

Crowds suppress the dissenting views of nonmembers

 

“You see, the reason stock prices move up and down so much is that we all like to join crowds, social groups of like-minded people. When such crowds form around investing themes in the stock market, they push stock prices too high or too low relative to fair value. Why? Crowds suppress the dissenting views of nonmembers and amplify the consensus views of their members. Crowd members act together, not independently, and when this happens the market price strays substantially from fair value.”

Crowds suppress the dissenting views of nonmembers

I would take against em!

I would take against em!

Contrarian actions are always lonely and very uncomfortable!

Contrarian actions are always lonely and very uncomfortable!

To buy when others are despondently selling and sell when others are greedily buying!

Contrarian strategies are the investment equivalent of seeking out social pain. In order to implement such a strategy you will buy the things that everyone else is selling, and sell the stocks that everyone else is buying. This is social pain. Eisenberger and Lieberman’s results suggest that following such a strategy is really like having your arm broken on a regular basis – not fun!

To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward
Sir John Templeton

It is the long-term investor, he who most promotes the public interest, who will in practice come in for the most criticism...For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion
John Maynard Keynes

To buy when others are despondently selling and sell when others are greedily buying!

If you believe the story everyone else believes...

If you believe the story everyone else believes, you’ll do what they do. Usually you’ll buy at high prices and sell at lows. You’ll fall for tales of the “silver bullet” capable of delivering high returns without risk. You’ll buy what’s been doing well and sell what’s been doing poorly. And you’ll suffer losses in crashes and miss out
when things recover from bottoms. In other words, you’ll be a conformist, not a maverick; a follower, not a contrarian.

If you believe the story everyone else believes...

Successful investors are said to spend a lot of their time being lonely!

In short, there are two primary elements in superior investing:
• seeing some quality that others don’t see or appreciate (and that isn’t reflected in the price), and
• having it turn out to be true (or at least accepted by the market).

It should be clear from the first element that the process has to begin with investors who are unusually perceptive, unconventional, iconoclastic or early. That’s why successful investors are said to spend a lot of their time being lonely.

Successful investors are said to spend a lot of their time being lonely!