Contextual investing 2 comments
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You can see this as a continuation from my article on Common Sense Investing. There, I mentioned the use of common sense in the investing process, with possible use of metaphors to aid the decision process.
There are no hard and fast rules to succeeding in the stock market. That is why so many different varieties of characters have succeeded, from the quintessential trader Jesse Livermore to the earthy Peter Lynch to the "buy-and-hold" Warren Buffett. This is what makes the stock market exciting: the unpredictability of things and the constant need to be on one's toes.
Consider the buying process. Do you buy when the stock has reached attractive valuations, or do you wait for it to stabilise and show a rally before buying? This relates to the concepts of averaging up versus averaging down, which I have pointed out has no clear answer and is strongly linked to the investor's philosophy. Now think about selling. Again, do you sell on the way up or do you wait for it to peak and start falling? The answer is often more clear-cut in terms of gurus' advice in this case: they advise letting the profits run. Yet again, if you were a fund manager holding a huge chunk of the stock, doesn't it make sense for you to sell into strength when your distribution can be absorbed easily by the market? And what if the stock has a history of high volatility and low liquidity? Or if it is selling at ridiculous valuations of >100 like Internet stocks during the dot-com boom? Clearly the size of one's holdings, the nature of the stock and its valuation is important in influencing what selling philosophy to adopt.
This is why I think reading widely on business and history in general is important, because it gives a more global view and historical perspective of things. Reading up on business gives one a more complete understanding of a certain sector, its history of development, its main protagonists, its future outlook, and what factors drive its development. This enables the investor to do a simple SWOT (Strength, Weakness, Opportunities, Threats) analysis that allows a swift and intelligent contextual analysis to be done before making a decision on a stock. An understanding of history, not just of the stock market, allows one to develop a broader perspective of linkages between social, political and economic factors, as well as a keen instinct of the impact of breaking news. As the saying goes, the more things change the more they stay the same.
Making investment decisions based on assessment of context and without reliance on any hard and fast rules should not be associated with a lack of trading discipline. The latter demands that one should not hesitate in implementing the decision once it has been made (after thinking through carefully). The two concepts are not mutually exclusive. However, there is this issue of intellectualisation, where the investor, having a subconscious desire not to sell a stock (eg. because he had put a lot of effort into researching it), rationalises it in his analysis process even though there are clear signals calling for a sell. Everybody has probably experienced this with a favourite stock before, and that's why it is important not to fall in love with a stock.
At the end of the day, I think it is quite impossible to communicate the nuances of contextual investing. It comes with experience, whether vicarious experience through reading books or actual trading on the stock market. Clearly one should do both to develop an instinct for making such decisions. And of course, never count on being right all the time. Investing is a percentage game, that is why it is more an art than a science.