Applying “the Force” to Investing

December 24, 2015

Applying “the Force” to Investing Photo

Last Saturday, I saw the new Star Wars movie. The movie was good and has been very popular within the political community as plenty of politicians are using the movie to gain support. The best so far was Hillary Clinton’s closing remarks at the Democratic debate: “Thank you, Goodnight, and may the Force be with you.”

The Force, for those not familiar with the Star Wars universe, is an intangible but magical power. A weapon or fighting move can become much more powerful when used in concert with the Force; a person gains superior strength and wisdom when it awakens.

What is the equivalent in investing? Self-awareness and intuition.

In simple terms, self-awareness is to know oneself. You want to know how you think and feel when you were making mistakes and be alert to similar situations in the future. You want to know how different mental states (fear, greed and hope) affect your decision making and learn to let them work for you instead of against you. You want to know when to listen and when to go against other people’s actions.

In “The Reminiscence of a Stock Operator,” a fictionalized version of securities trader Jesse Livermore wrote vividly how mental state affected his trading results. He was in debt for $1 million; a few creditors were after him to collect debt. This put severe strain on him and his trading result was terrible. He had to declare bankruptcy to clear himself from this psychological burden. In two years, he made $5 million, paid his creditors in full plus interest, even though the law did not require him to do so.

What a story!

For people who are interested in the real story, “Jesse Livermore – Boy Plunger: The Man Who Sold America Short in 1929” is a new book that covers all his life and is definitely worth reading. Livermore made $100 million during the 1929 crash and became one of the 10 richest people in the world. However, in 10 years, he committed suicide, dying almost penniless. He was the same brilliant speculator, but chaos at home and inability to handle the sudden wealth completely damaged his mental state. Without the right mental state, you lose money no matter what you do.

Behavioral finance continues to gain popularity among investors. In essence, behavioral finance is a study of symptoms of no self-awareness.

Over-confidence is one topic that is covered a lot in behavioral finance. For example, 90% of drivers think they are above average drivers. Another topic is investors’ tendency of keeping their “losers” and selling out their “winners.” If someone has the habit of reviewing past decisions and results, he will see how detrimental it was to his financial health. I use “he” because plenty of behavior finance research has found women are much better than men in investing. (I hope my household is an outlier.)

About the current market, my view is unchanged. For individual investors, this is not the market to make a lot of money; capital preservation should be priority. For institutional investors with a long-term time horizon, the credit market is getting interesting and above-average risk taking is probably a good way to maintain a value-oriented, counter-cyclical investment strategy. Risk taking during market stress will earn the luxury of not having to take much risk when risk premium is low.

Key Takeaway: As investors, we all read the same research, the same newspapers, and the same books. These tangible things are important, but they are not enough. Working on yourself, knowing yourself, developing intuition, maintaining a relaxed and alert mental state is the other piece of the puzzle.

Tags: Chart of the Week | Investment strategy | Jesse Livermore | Behavioral finance | Counter-cyclical

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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