Monday, October 13, 2008

Buy Low, Sell High

The mantra is so simple, so clear, so patently reasonable: "Buy Low and Sell High". Yet the investor who most famously sticks to this most obvious of strategies is viewed as a Grand Buddha Of Investment Wisdom. Most investors act on emotion, or chase feverish speculative strategies. They lose their money, of course, as any compulsive gambler must. Meanwhile Buffett makes billions following a simple strategy everyone knows but few diligently ply.

We prize adages; we love their simplicity and savor their wisdom. That's why our holy books are stocked full of them, and our media treasures sound bites. Yet we find it devilishly hard to follow through on simple principles. We all grow up appreciating those great Ben Franklin aphorisms, but how many people actually live any of them? The problem is that while our minds value simplicity, our natures yearn for complexity. We muddy our vision via endless distinctions and footnotes and we slog through the mud of habit, emotion, and cultural pressure until our actions become hopelessly fuzzy and irrational - and radically out of step with our professed values and beliefs.

Consider "Do Not Kill", the Biblical injunction which many of the most fundamentalist Christians not only violate but openly spurn. It's hard to find much evangelical objection to war, capital punishment, or hunting. In fact, all three are disproportionately popular with those who deem themselves Bible literalists. How is this contradiction maintained? First, distinctions - the mental footnotes which carve out wiggle room. We mustn't kill, except in self defense. Or except in the case of infidels and criminals. Etc, etc. Innate emotional propensities lead us to niggle, wiggle, and squirm until we've carved out subtleties in even the most blatant clarity. And, in the end,, one easily abandons self-critical faculties amid the righteous company of millions of like-minded fellow believers.

It's exactly the same with investment. A jillion people sold a jillion shares of stock on Friday. The early players, who got the jump on bad news and slipped their sell orders in before markets tanked, were wise to act. But crowd-followers vastly outnumber the crowd itself. They see sharp dips, they get scared, and they sell - after, rather than before the dip. In so doing, they've lost out on, and can never recover, the 6.4% jump the market made this morning. Per above, the Three F's: fear, flocking, and footnotes induced them to sell low. When will they put their money back in the market? After leaders have already driven up prices, of course. They'll buy high.

Let's face it: greed and fear, being innate human drives, are always in play. The trick to investing wisely, they say, is to subvert them by feeling greed when others are fearful (i.e. prices are low), and fear when others are greedy (i.e. prices are high). It seems to be extraordinarily hard for most people to do.

It should be noted, at the risk of adding the first of a potentially infinite number of muddying footnotes to the mantra's simple wisdom, that the mantra is
not "buy at the bottom and sell at the top". The attempt to do so is the worst pitfall of all. That's the very lair where fear and greed live.

This upturn will be followed by violent downturns, which will be followed by sharp upturns. That's how it works. Over time, money will be made by those who simply let their investments ride, and who sell only during buying frenzies.

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