Learning Emotional Detachment

So emotional

Investing in stocks is an emotional business. Once we've invested in a stock it is natural to will the price to go up. If the price starts dropping we start to worry.

The Buffett Way

Well, not if you are Warren Buffett. He points out that if the share price of your investment goes down, that is a good thing because you can buy more of the stock for less. Buffet is not looking to buy cheap and sell high. He is looking to buy stocks in companies with stable and growing earnings as cheaply as possible. He has his eye on long-term and short-term prices movements are just noise.

In fact he buys with the intention of never selling so he does not care what happens to the share price. The only thing that matters is long-term earnings. The only reason to pay any attention to price movements is to look for entry points to accumulate more good stocks on the cheap.

Buy? Sell? Hold?

But while temperament is important in being a successful investor, it is not everything. You also need to have the ability to analyse and recognise long term value.

This is why it is not easy to follow Warren Buffett. Every investor is trying to get edge. So when a stock we own starts ticking down we start to worry if there is something we've missed. What if this is dip is more than just noise? What if it is the start of a falling knife?

Should I just hold on and hope things come right? Should I stock up and average down? Or should I sell out and cut my losses? Certainly, I have done all these things at various times guided by no more gut instinct. Invariably, I ended up doing the exact opposite of what I should have done.

Buffet doesn't have these worries as he has inscrutable confidence in his ability to recognise long-term value. So, if a share price dips he will always buy more.

I am not Warren Buffett...

If there is one thing I am certain about it is that I am not Warren Buffett. I will never have his gifts at stock picking. However, there is one thing I can try to emulate - his emotional detachment.

Mastering your emotions is probably the single most important skill in becoming a successful investor. An emotional investor becomes part of the market but an emotionally detached investor can rise above it.

....I am the Mechanical Bull

This is why I have committed myself to a mechanical investing style. When faced with a challenge, I do not have to make a judgement about what to do that is coloured by emotion. The system will tell me what to do, a system that is designed on proven investment principles. I will never be as clever as Warren Buffett but I can be as disciplined.

10 Years of Stockmarket Investing

Early days

I started investing in shares in early 2003. My approach was pretty unsophisticated. I bought companies that I had heard of or that were tipped in newspapers. I made all the classic beginner mistakes - selling winners too soon, holding on to losers, on at least on occasion all the way down to zero.

However, I chose a good time to start investing as the FTSE 100 almost doubled over the next four and a half years. My modest portfolio did not do as well, but at least I didn't lose money.

Investing through the financial crisis

In about September 2007, as problems in the global financial started to emerge, I decided to liquidate my share portfolio and move (just about) everything into cash. There wasn't a whole lot of thinking that went into this - I just had a bad feeling. Although this was pretty naive I actually regard this as one of my better investment decisions. It helped me to preserve my modest gains through the depths of the 2008 crash.

In 2009 I started investing again. However, I completely misread the market, thinking there was a good chance that things would get even worse. I stuck to defensive shares that underperformed through to the end of 2010, but at least I didn't lose money.

Learning to do things properly 

In January 2010, I read a newspaper article about some ordinary guy who had turned himself into professional private investor. He claimed no specific gifts, just an eagerness to immerse himself in investment literature and company reports. I don't remember his name. The one thing I do remember was his belief that anyone could make it as an investor. This wasn't get rich quick - more like, get rich by learning how to enjoy the process of investing to get rich. In any case, this was an inspiration.

I began to read all kinds of stuff from Warren Buffett's "Letters to Shareholders" to "Value Investing for Dummies". I started using screens, following  a basic value based approach. I also started following rules like cutting losses of more than 20 per cent. The first time I did this was really hard, but seeing the share price subsequently fall in half, definitely took the edge off my disappointment.

The birth of the Mechanical Bull

Over the last two to three years I have moved towards a strict mechanical investing approach. I have come to the view that you need to follow an investment approach that suits your temperament and intellectual abilities. The type of forensic accounting favoured by most private investors does not suit me. To be perfectly frank, accounting doesn't interest me. I am a quantitative researcher by profession and so I like looking for patterns in numbers. A mechanical investing style suits me much better and I enjoy the challenge of understanding how they work.

Many people do not regard mechanical investing as a serious investment approach. However, it has been proven that very basic mechanical approaches can beat the market. For example, a strategy based on selecting a random selection of shares, selling just the losers and redirecting the funds into the winners, will on average beat the market. This is the basic principle behind momentum investing.

It is widely held that the average investor can not beat the market and so should simply invest in index funds. However, this very simple mechanical strategy that anyone can follow DOES beat the market. The fact that such a simple provable fact flies in the face of conventional wisdom never fails to amaze me. What's more if such a simple mechanical strategy can beat the market, what might be possible with something more sophisticated?

A final word

To be honest, part of the reason for starting this blog is that I thought that Mechanical Bull would be a cool name for an investing blog. But there is definitely a gap in the blogosphere around mechanical strategies. I hope this blog goes some way to filling that.

Finally, this blog does not aim to impart investment advice. I say this mainly because I am not qualified to do so. But I also believe that everyone needs to work things out for themselves...... like I have done and will continue to do.