Be Fearful When Others Are Greedy and Greedy When Others Are Fearful

Irrationality Be Fearful When Others Are Greedy and Greedy When Others Are Fearful

How insightful is that!? Have you ever heard that before? I bet half of you just had some sort of financial-religious experience and half of you have rolled your eyes so hard that you’ve gone cross-eyed.

While I jest, this particular oft-quoted Warren Buffett saying is all at once insightful, vague, and more often than not extremely difficult to follow. While I pride myself as someone who operates through life based on cool-headed logic and rationality, I must admit that irrational emotions constantly bubble to the surface, no matter how hard I try to keep it contained.

The second half of 2015 into 2016 has been a very interesting time in the markets, and in particular, our equity portfolio. There has been much volatility, even more so in the portfolio. While the portfolio continues to sail on, with no rash actions taken in the accounts, if I was being entirely honest, there has most definitely been moments where emotions have crept in.

I feel intellectually lazy when I allow feelings of greed to creep in when the markets are going up. I feel intellectually dirty when I allow feelings of fear to creep in when the markets are going down. I know that short-term, day-to-day, month-to-month movements in equities are meaningless in the long run.

Yet, even for me, someone who profoundly understands the subtleties of Buffett’s quip, I experience those tinges of greed and fear at the exact wrong moments. And it makes me question whether I can ever truly, entirely escape the evolutionary brain wiring that make us irrational in the face of greed and fear.

I’ve read books like Robert Cialdini’s Influence: The Psychology of Persuasion to try to puzzle together what makes our irrationality tick. I continue reading in this field of neuroscience and psychology, like Douglas Fields’ Why We Snap: Understanding the Rage Circuit in Your Brain, to further expand my understanding of irrationality and how to work towards mastering it.

Although the concept is genuinely simple – to be fearful when others are greedy and greedy when others are fearful – our brains are not wired by evolution to run with this script; it’s wired to do the exact opposite, which is why we experience herding behaviour and bubbles in the stock markets. Succumbing to fear and greed at the wrong moments can lead you astray, with spectacularly disastrous results.

It’s all very interesting. To be successful for a long time in the markets, you need to be able to do the exact opposite of what your brain is evolved and wired to do. I think that is in part explained by the fact that we are running 21st century software on hardware that was last upgraded hundreds of thousands of years ago.

Evolution is a horrifically slow process. Our brains are evolved and developed for surviving on the African Savannah. It served us extremely well for a million plus years, evidenced by the fact that you are sitting there reading this. The world we live in has changed dramatically in the past 10,000 years, which is a mere blink of an eye relative to the scale of time evolution operates on.

I can truly appreciate now how this game is not easy for most people. Most people either do not have the naturally gifted temperament or do not develop their knowledge and wisdom to possess the correct temperament to operate in the stock markets. I firmly believe that temperament is the most important ingredient for long term success in the markets.

And I continue to read, ponder, and analyze how you remain resilient in an ocean of irrationality by developing a purely rational and logical thought process towards investments in the stock markets, with one of the methods borrowed from Charlie Munger’s process of a latticework of mental models.

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2 thoughts on “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful

  1. It’s really amazing, isn’t it? The same thing has happened to me. When things are risk-on, everything really does look better. And when things are risk-off, armageddon seems to await. There’s really nothing like managing your actual money to understand what it’s like. Hopefully this experience will be one to have learned from, not one to be repeated (although sadly, the latter appears to be what usually happens).

    1. I’ve seen a long position drop into the negative 40% range during the worst of the volatility recently, and while it did raise my eyebrow, it’s still sitting there. I know that there is good probability of a solid outcome if held for decades, but the way our brains our designed, no matter how much logic you use, time frames of decades are still difficult to fully comprehend and those animal spirits inevitably tremble from time to time.

      I take it all as a learning experience. It helps me gauge what risks I’m willing to accept and which I am not. It makes me appreciate even more the concept of risk-adjusted return.

      You are right: there is nothing like actually having skin in the game.

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