Part 1: Sell High
“Most of the fundamental ideas of science are essentially simple, and may, as a rule, be expressed in a language comprehensible to everyone.” —Albert Einstein
It would be easy as an industry insider to wax poetic about financial topics using big words and acronyms to sound intelligent. It would yield tremendous credibility to wield verbiage such as contango, earnings multiple, candlestick, and backwardation. (Yes, candlestick is an investment term.) It would be fun to write of personal predictions for markets and inflation — being the guru and preaching my prophecy. And, let’s be clear, even the best of us is likely to exercise our financial vocabulary and show-off a bit every now and again. However, in the complex world of finance and securities, nothing is more challenging, both for an author and for a portfolio manager, than to keep it simple.
It is immensely difficult, in finance as in all aspects of life, not to drift into complexities that make both the reader and the writer feel intelligent as a result of their fanciness. And while even this may seem a convenient and cute introduction to just another “how to” article, nothing could be further from the truth. Nothing is more important to the long-term success of a pool of assets than the absolute simplest of concepts.
In a portfolio of properly positioned securities, it initially seems a fairly easy endeavor to sell an asset when its price has appreciated. The goal of investing, after all, is to make money. (Academia prefers a more precise definition, such as, “Investing is the commitment of current money in anticipation of a larger future flow of money.”) Investing, therefore, has nothing to do with might — dissimilar to a weight-lifting competition whose participants battle to lift more than each other. By definition investing is about a larger future flow of money, not the largest future flow of money. In markets there are many winners (and many losers), with no first prize for the most dollars made, no gold medal for those who push a stock to its absolute limit.
Given the above definition and being that markets are cyclical in nature, an investor who has earned a significant amount of return in a particular stock, for example, would be happy to take monies off the table. While Apple Inc. (AAPL), during the two year period ending Sept. 20, 2012, grew from $275 per share to more than $700, a proper investor sells along the way. In Apple’s case, as is typical, the opposite occurred. While AAPL continued to rise over that 24 month period there were significantly more buyers than those wanting to sell. It is what makes a stock appreciate: When there are more buyers than sellers, the price goes up. And as prices rise, more and more buyers, fueled by ego and greed mostly, enter the market pushing the price even higher still. Buying into an up-market or security despite the definition of investing or any amount of common sense. Consequently, what drives near-term volatility in prices is very typically not a change in valuation or in fundamentals, rather, investor emotion mixed with a lack of humility causes so very many to undervalue the day-to-day randomness of prices while over valuing their own ability to predict.
Success in investing is defined by obtaining your expected return (and perhaps, if you know what you are doing, with the least amount of volatility.) Success has nothing to do with who can bench press the most — which raises an important, interesting question: Why do investors abandon the definition of investing, refusing to sell their shares whenever prices climb higher and higher? That is, why do investors find it overwhelming difficult, as expressed in their actions much more so than their words, to sell high?
Part 2: Buy Low
“That’s been one of my mantras — focus and simplicity. Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains.” — Steve Jobs
The most challenging aspect of investing is buying into a down market or security. During the first six months of 2010, for example, Google (GOOG) depreciated more than 20 percent, while a comparable stock such as Apple (AAPL) was up over 36 precent. It was a divergence of big name equities exemplifying the simplest concept that, to this day, remains elusive to investors. At the time, Apple, for its near-term performance, received praise and became the darling of global financial markets. Google, despite Apple’s rise, pushed lower and lower in the stock market and lost all luster as sellers lined up to offload shares. It was a game of hot potato relative to Google stock, finding many playing along but few able to stand the heat of a great company on sale. In retrospect, with Google appreciating near 80 percent since then (and Apple under-performing its rival over this same time period of the last three plus years), the first half of 2010 was a buying opportunity relative to the global tech giant with strong business lines in search engine optimization, social media, and the mobile space.
In recent days, one need not look far to find new examples of beaten prices ripe with opportunity — gold, as an example, currently being the “wicked step-child” of portfolios universally. Purchasing a security amidst considerable downside price pressure makes so much sense for all investors but is so damn difficult for the vast majority. Most sell on the way down — precisely what makes a price depreciate. The more sellers, the more the price continues to drop. (That is, due to the way markets work, we know empirically that investors sell into a down market.). But why do investors, armed with such simple and powerful knowledge as “buy low,” usually execute the opposite? Why do investors, solely on the basis of recent “negative” price movement, refuse to purchase a security when all that is simple and effective instructs them otherwise?
Despite its obviousness, buying low is the most difficult activity in financial markets. Some struggle with the decision, while others are so overwhelmed by recent price changes they are completely blind to the opportunity. The human brain and near-term performance have a cause and effect relationship with investors’ desperate (and erroneous) need to buy the hot security — chasing Apple stock on the way up, for example. Not chasing the trend means buying low, placing dollars in a security that is out-of-favor and experienced a recent price drop; an exercise by far more daunting a challenge than any other facet of money management.
Most investors, over the long-term, underperform markets; the average long-term return of Joe Investor is far below that of the market itself. Most are driven by jargon and high prices. Executing that which is simple takes clearly defined objectives, a methodical approach, and mostly a great deal of patience and humility. Buying low (similar but much more difficult than its sister — selling high) is an endeavor which requires maturity, calmness, and a tremendous knowledge of self. In securities, almost no one likes a sale; unfortunate, as long-term success is primarily determined by one of two factors: 1) simplicity (i.e. buying low), or 2) luck (i.e. candlesticks and earnings multiples.)