Wednesday, November 25, 2009

“Everybody has a plan …..”

“Everybody has a plan till they get punched in the face”. This brilliant quote can be credited to the famous American philosopher “Mike Tyson” :-) . ( His detractors might point out his fetish for ears but didn’t Vincent Van Gogh also cut off his ears).

It’s a extremely impactful statement with implications for any participant in the stock markets. We plan for all kinds of scenarios that the market throws at us. For ex Looking at the market right now we could plan that if the market corrects by 20% we could deploy additional capital into the markets. Simple statement of intent or plan factoring in a possible scenario.

It becomes easy to implement this plan if the market gradually drifts down a percent or two every week and winds up going down 20% over a six month period. It’s a series of small punches that the markets throws at you which tires you out but keeps you in play to deploy the action plan that you had thought thru.

The challenge is when you get punched in your face by the markets when they correct 20% in a week or fortnight. At that moment the mind freezes and all the best laid plans of men and mice go waste. Fear and self doubt seeps in and the reptilian brain takes over.

The R-complex as it is called overrides the more rational functions of the brain and results in primitive behaviour where the survival instinct takes over. We of course see that in the rush to the exit door that happens with market participants.

Can we work our way thru this and retain our rationality? I think the first step is being able to recognise when our mind starts moving into this state.
The awareness of it might helps us deal with a few punches thrown between our eyes.


Mayank said...

Interesting Topic Ninad -- My thoughts are:
No matter how well we know that when others are fearful, we should be greedy when the market makes that large 20% move down we simply would run for cover rather than think of deploying additional cash. Studies have shown that we are wired such that an X amount of loss hurts us much more than an equal X amnt of gain, hence we are programmed to be more fearful than greedy. Thats why you would notice that the markets move down with much more ferocity than their upmove.

So only highly evolved investors based on lot of past experience can possibly control their instincts to duck for others the story ends always with the same result

Nandy said...

It can be easier if you go company by company, of course, after doing your due diligence. If you have a price on your head for a good company, below which you want to buy it, irrespective of what the broader junta feel, it is important to go ahead as per plan. And that, is something that can get cultivated - though not easy, I must say. The same modality can apply for selling too.

Ninad Kunder said...

Hi Mayank

Loss aversion that u refer to is still relatively easy to manage and overcome as a behavioural defect.

What is more difficult is when the reptilian part of the brain takes over, it becomes very difficult to take rational decisions. One can avoid panic attacks or the rush to the exitdoor. But in that state the brain starts to rationalise that there are strong reasons for the downturn. So what is really a state of fear gets rationalised as a objective decision.



Ninad Kunder said...

Hi Nandhita

The state happens not just with respect to the broader market but also when we encounter a negative event in a individual stock.

As a matter of fact I believe it is more difficult to manage it when it happens to a individual stock. I can still manage a broad market meltdown bcos u can see the apparent irrationality playing out. But when it happens wrt a individual stock that u own the irrationality is not as apparent or all pervasive and the mind then moves into the state of questioning the original hypothesis.