You’re sitting on the coach at home when your friend storms in and tells you that your favourite beer is on sale in your supermarket. And that your favourite clothing store is selling everything with a discount right now. Oh, and that huge ultra-modern Smart-TV you always wanted is on sale as well.
It takes you about 5 second to put on your shoes and rush to the city to get your hands on all the goodness. Evidence: Black Friday. But when we talk about a Black Friday in the stock market however, many investors try to sell their stock in total panic.
Why do so many people love sales and discounted products, but become scared as soon as it affects their investments? It is simply because the human brain is designed to protect further damage to the individual. Unfortunately the brain does not recognize the opportunity that is hidden in plain sight amongst all the chaos.
Like Warren Buffet said : Be fearful when others are greedy, and be greedy when others are fearful.
The Nature of the Beast
It goes against human nature to buy a stock when the world seems to fall apart. Many investors sell at those moments and you shouldn’t be one of them! As long as you invested in solid companies and other broad diversified investments you have no reason to sell.
The greatest paradox of all human psychology probably exists in the stock market. The main goal of an investor should be to maximize their returns for the longest possible time by making solid investments. However, many investor go straight against that goal without even realizing it.
Buying At the Top of Optimism
A common (psychological) mistake made by investors is that they are confident about investing, simply because the market shows signs of confidence. The returns on investments are growing, and among all the positivity many investors are tempted to buy even more (everybody is confident so what could go wrong, right?).
The result is that they buy at or near the points of maximum optimism. That is like buying a new car, a six-pack of beer or whatever you like, for the highest possible price.. That makes no sense at all! It is just an overconfidence bias in the brain of many investors, which can result into big losses.
Imagine we are now a year further in time, the economy of China shows signs of stagnation, the Greeks are causing a big upset in the Eurozone and pessimism hits the market. Your previously bought investments have already lost 5% of their value but you can still handle the downturn. Now it turns out that the Greeks credit crisis is worse than expected, and panic hits the markets.. your investment loses another 15% over the past month and now you are down 20%.
Doubt and insecurity creep into your brain ‘How much worse will this mess be? Should I sell? If I sell now then I will at least save some of my money, god knows how much more I could lose.’
So you sell your investments and leave the field demotivated, losing 20% on the ‘investment’. 3 months later the markets have recovered more than 10%..
And that, ladies and gentlemen, is the strategy to follow if you want to lose money: Buy high, sell low.
Buying into Pessimism
Now what is the strategy that will make us money? That is buying at the points of pessimism. Let’s call it buy low, sell high. We can tell you straight up that it’s near impossible to buy at the maximum point of pessimism, and it is very likely that you buy somewhere between the ‘panic’ and ‘relief’ stages of the cycle of market emotions. Expect your investment to lose some percentages in the short term (could take a couple of months!).
Now there are some strings attached to this method of course. Make sure you do your research and only buy stocks of the most solid companies on the planet. Preferably, invest into a diversified index funds or ETF which contains relatively safe countries such as the US, UK, Germany or Japan.
You shouldn’t invest just because the prices are low. Just like you wouldn’t buy a broken car even if it is on 60% discount. Only invest in solid companies, which you have analysed thoroughly, or in reliable index funds and ETFs.
So, with that, hopefully you have an understanding of how depressed markets offer excellent investing opportunities.