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What is the biggest challenge for an investor?

Posted by Dan on June 5, 2014

Investing or trading with some degree of success is not an easy task. I asked the question on some social networks: “What do you consider the biggest challenge for an investor?” Some readers took the time to answer:

* Jeff Pierce, “Changing with the market. It’s the periods where the market shifts that wreak the most havoc to our portfolios.”
* Daniel Ocean: “Not letting their emotions overcome their objective trading plans. Still a battle for me.”

Good answers, and offering an interesting contrast. The market is a chameleon indeed, and remaining flexible in the face of changes is a tough job. But how flexible? Emotions can cause investors to give up on their trading plan, typically right before their system is to embark on a string of profits. Maybe these investors also think they are being flexible and going along with a clear market shift?
We easily blame our emotions when we sold out at the bottom or when we bought near the top, but do we ever credit them when we acted on gut feeling and these same “emotions” got us out just before a major market drop? Maybe our emotions would become more reliable indicators if we took the courage to trust them a bit more often? Not easy questions.

Emotional balance can be hard to find (and keep) indeed, and that’s why fear, greed, flexibility and discipline are the topics of many books on trader psychology. But today I want to talk about another factor that doesn’t get the attention it deserves. Investors can learn the lesson of “fear-greed”, they can get to a sufficient level of “flexible-discipline” when it comes to their trading plan, but then the biggest challenge awaits them: how to deal with profits. This is the third pair on the traders’ emotio-rama: pride-humility. It has happened to me and I have seen it happen to many others: a string of profits has come rolling in and one starts believing that some holy grail was found. And this over-confidence starts oozing out: a bigger car is being bought, or a lush villa in some exotic paradise.., jobs are being quit to trade full-time, only the best hotels are good enough when traveling,.. AND the whole world has to know about it! When you observe that in yourself or in other investors, take note. It usually sets the person up for a string of losses. Not because some kind of “wrath of the gods” but because the behavior reflects a special type of emotional imbalance that will start to affect his trading decisions eventually. And I think this has been a very big element in Warren Buffett’s long term success, as he has carefully avoided this pride-trap. He has continued to live in the same home, drives a rather normal car, hasn’t picked up a much younger wife, doesn’t wear expensive suits and isn’t paying $millions for classic paintings.

It also explains why for example Sotheby’s stock (BID) has been such a good leading indicator: How Sotheby’s predicts the world economy. When very wealthy people start paying ridiculous prices for art and collectibles it indicates an extreme in the pride-humility cycle, which is probably more significant than the extremes in the greed-fear cycle because the “1%” own such a large portion of the stock market.
I keep an eye on Sotheby’s stock for this reason, and the stock is in an interesting place right now (click for larger image):


Sotheby’s has been in a correction since the start of the 2014. Has it topped out in the $50 resistance area once again? It is possible, but with many markets setting new all time highs I would expect BID to rise to a significant new high before this bull market is over. And it hasn’t done so yet. Technically my Earl indicator is starting to bottom out and that could set the stage for a climb to $80-100 in the next couple of years. That would then reflect the kind of over-confidence that comes with major peaks. Important support is near $35 and then $30, so if BID drops below these levels it would reduce/remove the odds for this scenario, and indicate that we have peaked already. If you want to check out how art auctions are going, is a good site to do so. Recently you can see GBP millions being paid for paintings that were expected to fetch GBP 50k. Crazy, or just warming up to get even crazier? What does it tell you?

Good luck,

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4 Responses to “What is the biggest challenge for an investor?”

  1. Bill said

    does it look like LT wave is not following through this time.

    • Danny said

      Hi Bill,
      Just five days into the month it is a bit early to review the LT wave for June, don’t you think?

      • Bill said

        most of the time LT wave follows quite good. If it fails and we can figure early and position accordingly. Or just stand aside.

        Anyways we are entering lunar red period.

      • Danny said

        The LT wave is still experimental. Wouldn’t put too much trust in it just because it has had some good months. If the expected pattern doesn’t materialize it is always best to forget about the LT wave until the expected cycle re-emerges.
        We are in a lunar red period, but bear in mind that long term expectation for red periods is not down (See performance page). Taken over more than 60 years the red periods have a slightly positive expectation, just much weaker upside than in the green periods. So, there is no money to be made by systematically shorting the red periods. When other factors fall into place (e.g technical considerations, trend lines,..) then it is possible to go short in selected lunar red periods.


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