#Truth about investing 102-Efficiency and behavior

This is taken from a presentation by Howard Marks Co-Founder of Oaktree Capital. This is the second in the series of articles. Mr Marks makes concise and incisive comments about the art of investing that can help amateur and professional investors alike.                                                      

Most investors behave pro-cyclically, to their own detriment.

In a rising market, even fundamentally weak companies look great technically. Fear of Missing Out (FOMO) kicks in, making people more optimistic and causing them to purchase at market highs. When the inverse is true, their pessimism grows, encouraging them to sell at cyclical lows. As a result, the retail investor is left with equities with high purchase prices but poor fundamentals.

Cyclical ups and downs don’t go on forever. But at the extremes, most investors act as if they will.

At market extremes, emotions- fear and greed are at their highest levels. People buy at market highs and sell at market lows. When people start believing in trends rather than market cycles, that’s when behavioral mistakes occur. It is usually best to ignore the current market and stick to the fundamentals at sky high emotions.

It’s important to practice “contrarian” behavior and do the opposite of what others do at the extremes.

Market does not trade at extreme ends for a long time. When there is a widespread notion that there is no risk, investors believe it is safe to engage in dangerous behaviour. Acting contrary to the market during phases of soaring emotions might provide us with optimum entry and exit points. As a result, we must sell when others are greedy and purchase when they are fearful.

While not all markets are efficient – and none are 100% efficient – the concept of market efficiency must not be ignored. In the search for market inefficiencies, it helps to get to a market early, before it becomes understood, popular and respectable.

Humans are predisposed to identify patterns and exploit them; however, these patterns and trends are already priced in by the markets. Higher the efficiency of the market the faster are the patterns and trends priced in. In established markets, however, efficiency diminishes the frequency and scale of opportunities to overcome the consensus and identify mispricing or inefficiencies. The sooner you invest in an inefficient market, the easier it is to profit as markets become more efficient. If the other investors are few, inexperienced, or prejudiced, you will have the first mover advantage; as Warren Buffet correctly stated, “First comes the inventor, then the imitator, and last the fool.”

Source: Howard Marks- Truth About investing.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”