minimum risk – LUCKY IDIOT

We cannot predict the future and cannot see the future so that can we prepare for the future? How can we be positioning our investments? Answers to these questions lie in the understanding of the cycle and at where we stand at the current cycle.

MMC13 01-min

It’s not always what we buy that matters but at what price we are buying that matters a lot.

MMC13 02-min

MMC13 03-min MMC13 04-min MMC13 05-min

These checklists help us to an understanding regarding cycle and where we stand at the cycle. That understanding helps us with what we should do and what can be the portfolio positioning. These checklists also help us to remove some mistakes such as buying little when risk is low so that capital allocation decision also can be improved. The capital allocation also one of the key elements to becoming a successful investor.

We all see the everyday events which were covered by the media but we also need to put effort to understand that what it is going to indicate to us. These efforts help a lot to us. I got saved in recent market turmoil due to understanding of the cycle which I have practised after reading “The Most Important Things”.

I want to quote my learning from the most important things here to explain this concept with a few additions.

The earlier scene in the year 2017-18

Auto Good-min

The current scenario in the year 2019-20

Auto Worst-min

We need to focus on the current scenario what it is indicating to us, not to worry about the future. If the current scenario tells us to stay away and we are into the third phase of the bull market then we need to adjust our portfolio accordingly. And if the current scenario suggests the third phase of the bear market then we need to adjust our portfolio positioning accordingly. We cannot track each and every information flowing around the world but we need to understand which of them are important and help us to reach the conclusion.

When market and psychology of the investors flying then do not care for the valuations. People argue that old valuation techniques do not work in the current period. Another argument is that we should look at the business, not stock so that valuation does not matter. But what happens to this logic when bear take a charge?

Old technique again starts taking place. Higher P/E looks as an unhygienic for the health of the portfolio and low P/E tempted to the investors.

Infobeam & 8K-min

We can see that during the bull period even non-qualitative companies also traded at the multiple of quality companies.

There are qualitative and quantitative two phenomena which we can study to understand where we stand in the cycle. We always need to ask the question to ourselves how the assets priced and how the investors around us behave? That means the quantitative part refers to the valuation of the assets. And qualitative part refers to the behaviour of investors around us & understand it.

MMC13 07-min

Example – one of the E-Commerce company of India

Infibeam-min

Infibeam Chart-min

When the market is booming, the psychology of investors is positive, economy growing, people are eager to make an investment then low-quality securities also getting issued by providing a better rating.

MMC13 08-min

We have to be contrarian, have to learn to go against the wind prevailing in the market.

When market falling, people tend to stay away from it. They argue that keep away from catching a falling knife. But when dust gets settled and we realize that the final bottom has made, a bargain will also be gone.

There is no way to know when and at what price exact bottom has made. We come to know about the bottom only after it has made.

MMC13 09-min

We should avoid buying with leverage money because when pendulum moves towards extreme pessimism then we cannot able to know where it will stop and we get a margin call, due to the leverage. We get a disastrous outcome of such an act.

John Maynard Keynes is reputed to have said: “The market can remain irrational longer than you can remain solvent.”

When the economy is in a troublesome period and investors psychology also negative then only, we get a good asset at a bargain price.

We have a two-risk scenario – one is a risk of losing money and the other one is a risk of missing out an opportunity. Investors have to make a balance between the risk. When market moving higher in the cycle, we have to focus more on the risk of losing money and when market-moving lower in the cycle, we have to focus on the risk of losing the opportunity. When there is a high chance of losing money then we have to play defensively and when there is a chance of missing out an opportunity then we need to play aggressively.

The cycle is going to happen and how we respond to it is the key matter. Successful investors are those who have survived under the different market cycle and that cycle makes them more thoughtful.

Disclosure – Companies mentioned in the article are just for an example & educational purpose. It is not a buy/sell/ hold recommendation.

Read for more detail: Mastering The Market Cycle: Getting the odds on your side by Mr.Howard Marks

As an investor, we have to deal with the prices of assets and evaluate where currently its standing and what can be in the future. Prices of assets are getting affected by fundamental and psychology.

Psychology of the people does not remain the same forever. It will change for any of the reasons for millions of reasons.

Rising prices of the assets make investors’ psychology in the optimistic area and falling prices of the assets make investors’ psychology in the pessimistic area. The reason and result for the occurrence of the cycle do not remain the same with all the cycle but it is sure to a repetition of a cycle. Performance numbers are already recorded and sometimes, we require skill to understand it thoroughly. This is a past and we are not able to predict the future. It is essential to roughly think about the future to protect our investment. Second-level thinking also help us to understand the psychology of the market participants and act according to our conclusions.

There are few factors which influence and force cycle to occur.

Confirmation bias where investors seek for a piece of information or events which supports the thesis or not.

The tendency toward non-linear utility where we value a money loss is far greater than money made.

The gullibility is which influence the investors to swallow tales at good times which have the potential to gain at a good time and the excessive scepticism that makes them reject all possibility of gains in bad times.

Risk tolerance and risk aversion which investor ask for risk premium for the incremental risk.

Herd behaviour indicates to act with keep in mind that what the other people are doing.

One of the highly influential bias is to see other people making money with the idea which we have rejected initially. We do not resist such situations and left with the buying those assets which resulted in a boost to the asset bubble. Also, we generally do not select an unpopular idea and prefer to go with the herd.

All such biases lastly transform into the greed for more, envy of the money others is making, and fear of loss.

A bull market where prices of assets risen, rising or will raise and bear market where prices of assets fallen, falling or will going to fall.

But there are three-phase of the bull market –

In the first phase, growth and better improvement are invisible to most of the investors. Because it does not have a huge price appreciation, also occurs after the crash, wipeout of the prices has affected the psychology of investors.

In the last phase, prices of assets have risen, improvements are visible & started a long back. This improves the mood of the market and investors where they are ready to pay any price for the assets.

It is obvious that those who buy assets in the first phase, those got assets are at bargain prices and the probability of making money is huge. Whereas those who buy assets are at last phase then assets are available at costlier prices so that probability of losses are higher.

“What the wise man does in the beginning, the fool does in the end.”

Warren Buffett has said much the same thing even more concisely: “First the innovator, then the imitator, then the idiot.”

As we have seen three phases of a bull market, there is also a three phases bear market.

We have to see the problem behind the scene. Because an excess of good things always invites trouble. And an excess of pessimism gives birth to the new era of optimism. We need to focus on each little thing happening into the surrounding which helps us to recognize problem or opportunity earlier than others.

People always get pain when they see others are making money so that they fear continuing of trend and they will miss out on an opportunity. Thus, they also join the trend. Such influence affects the investors who have rightly enter at the first phase and by affecting the psychology, they again enter the last phase where they involve doing the wrong things. The most brilliant person also can fall under such psychological influences.

We also have to understand that the bubble is not always where the market raises and also not bust where the market falls.

If the company is good in quality then also it has taken around six years to reach the same price but if assets are not good quality then it gets disappear after the bubble get burst.

No assets are good enough that it will never be going to become overvalued. Price does not matter and borrowing money to make an investment are a sign of building a bubble. I have met a few of the people who take a loan on credit card, use credit period to trade in the market. Such is a sign of the bubble. This was an incident of late 2017 and starting of 2018.

We can see that good news, maximum availability of the credit, maximum optimism in psychology, maximum prices, minimum potential returns, etc. All come at the same time, which is a signal for the identification of the bubble.