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Emotional Control: Fighting the Urge to Short Mickey Mouse and the BlackBerry

I had an uncontrollable urge to short the Walt Disney Company (NYSE:$DIS) last night.

It had nothing to do with the company’s growth prospects.  In fact, if anything  I think most of Disney’s businesses have a bright future.

No, my sudden desire to short the company came when my three-year-old son, bursting with hyperactivity  after watching Mickey and the gang do the hotdog dance on the Mickey Mouse Clubhouse,  headbutted me in the nose while I was reclining on the couch reading a book.

Little Charles Jr. got to spend the rest of the evening on the naughty mat while Daddy iced his nose.  And luckily, the market was closed, so I wasn’t able to do something impulsive like load-up Trader Workstation on my phone and take out my frustrations by shorting Disney.

I tell this ridiculous story to make a very real point.  It can be extraordinarily difficult at times to suppress our emotions as investors.  Fear is the emotion that usually causes us to make the worst trading decisions; we often feel the urge to sell after a stock has already fallen substantially—at precisely the time we should be buying.

But anger is an emotion we have to contend with as well.  After getting burned trading Research in Motion (Nasdaq:$RIMM) last year, I am the first to admit that I am no longer objective on that stock.  Not only do I hate management, but I also hate the stock itself, as if it were an individual who had personally wronged me.

Ridiculous?  Yes.  But these are the emotions we deal with.  And if you feel yourself losing your objectivity, it’s time to walk away from that particular trade, long or short. (See also “Zynga: When You Lose Control of Your Emotions It’s Time to Stop Trading.”)

Today, I see a lot of emotion among investors in RIMM.  The stock (and its product, the BlackBerry) has die-hard fans and rabid haters…and not much in between.

I have no position on RIMM, at least in the short term.  The company faces stiff competition from Apple ($AAPL), Google ($GOOG) and Microsoft ($MSFT).  It still has a strong (though weakening) position among enterprise clients and in emerging markets, but I suspect a fair bit of this is based on RIMM’s lower prices.  Given the abundance of cheap Androids flooding world markets, that’s not an advantage I consider sustainble.  Still, BB10 has gotten high marks as an operating system, and the major carriers have agreed to support it.  The company may yet have a few tricks left up its sleeve.

My advice?  If you want to play RIMM, long or short, have trading rules in place that will mitigate your emotional responses.  Use some sort of risk control, such as a stop loss or trailing stop.  And it might be a good idea to have specific price objectives to help you pull the trigger and sell to lock in gains.

Disclosures: Sizemore Capital is long MSFT. This article first appeared on TraderPlanet.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Investing Lessons: Avoiding the Peter Lynch Bias

The single most important lesson I’ve learned about being a successful investor is the need to maintain emotional detachment.  Any feelings you may have towards a stock are unrequited.  If you love a stock, it will not love you back.  And if you hate a stock, it will not give you the satisfaction of responding in kind.  (As tragic as unanswered love may be, unanswered hate is often more damaging to your pride.)

A stock is like that unattainable cheerleader you had a crush on in high school.  She neither loved you nor hated you; she was completely unaware you existed.

No matter how much you love a stock (and write favorably about it in MarketWatch) it will not reward your loyalty by rising in price. And heaven help you if you allow your emotions to cloud your judgment in a short position.  I know of no surer way of losing your investment nest egg than to short a stock or other investment you hate.  Alas, I know from experience; I shorted the Nasdaq 100 in the fall of 2003.  In an outbreak of moral high-horsing that has (thankfully) now been purged out of me, I decided that tech stocks were overpriced and needed to fall further.  The Nasdaq had very different ideas, and I was forced to cover that short at a 20% loss with my tail tucked between my legs.

A closely-related investment mistake is succumbing to what I call the “Peter Lynch bias.”

Peter Lynch ran the Fidelity Magellan fund from 1977 to 1990 and had one of the best performance records in history for a mutual fund manager—an annualized return of over 29% per year.

Unfortunately, he also offered some of the worst advice in history when he recommended that investors “invest in what they know.”

On the surface, it seems like decent enough advice.  If you stumble across a product you like—say, a particular brand of mobile phone or a new restaurant chain—then it might be reasonable to assume that others will feel the same way.  If the stock is reasonably priced, it might make a good investment opportunity.

Unfortunately, “investing in what you know” tends to create muddled, emotionally baggaged thinking.  The fact that you like Chipotle (NYSE:$CMG) burritos and are intimately aware of every ingredient used in the red salsa does not automatically make Chipotle a good investment any more than your liking of Frappuccino makes Starbucks (Nasdaq:$SBUX) a good investment.   Rather than give you an insightful edge, liking the product causes you to lose perspective and see only what you want to see in the stock.

How do we mitigate our emotional impulses?

In a prior article, I noted that “brain damage can create superior investment results.”  But short of physically re-wiring our brains, what can we actually do?

I try to follow these basic guidelines and recommend them:

  • If you like a company’s products, try using one of their competitors before seriously considering purchasing the stock.  If I had really taken the time to learn how to use an Apple (Nasdaq:$AAPL) iPhone or Google (Nasdaq:$GOOG) Android device, I probably wouldn’t have gotten sucked into the Research in Motion (Nasdaq:$RIMM) value trap. Yes, RIMM was one of the cheapest stock in the world when I recommended it last year.  But I cannot deny that my decision to recommend it was biased by my ownership of a BlackBerry phone.  Likewise, many iPhone owners are probably buying Apple for similar reasons today.
  • To the best extent you can, try to follow trading rules and use stop losses.  What works for one investor will be very different than what works for another.  Perhaps you use a hard stop loss of, say, 10% below your purchase price.  Or perhaps you use a trailing stop or 20-25%.  If you are a value investor, perhaps you base your sell decision on valuation or fundamentals rather than market price.  But in any event, my point stands.  Lay out the conditions under which you intend to sell and stick to them.  Stock ownership is a marriage of convenience with quick, no-fault divorce if your situation changes.  Don’t make the mistake of falling in love.
  • Unleash your inner Spock.  For readers who are not Star Trek fans, Spock is an alien from the planet Vulcan who is incapable of feeling emotions.  When talking about a stock or watching its price fluctuate gets your heart racing, take a step back and try to look at the investment through Spock’s eyes.  Is it logical?  Do the numbers make sense?  Are the growth projections based on reasonable facts or on optimistic hope?  Would you buy a different company if it were trading at the same price multiple?

Admittedly, these are not precise guidelines.  But then, another lesson I learned is that it is a mistake to try to be too precise in this business.  Follow the lead of great value investors like Benjamin Graham and Warren Buffett by making sure you have a wide margin of safety in your assumptions.

Disclosures: Charles Sizemore has no positions in any securities mentioned. This article first appeared on MarketWatch.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Brain Damage Might Improve Your Investment Results


Brain damage can create superior investment results, at least according to James O’Shaughnessy in his classic What Works on Wall Street.

O’Shaughnessy refers to a study by Baba Shiv of Stanford University that found that people that had suffered damage to the amygdala or the insula regions of their brains made better investment decisions and had higher returns than those with normal, healthy brains (see the 2005 Wall Street Journal article on the same study).

As it would turn out, those two brain regions happen to control how we perceive risk.  Shiv found that his healthy test subjects allowed their prior losses to cloud their judgment, causing them to be excessively risk averse.  Meanwhile, the brain-damaged investors had no such inhibitions and approached each new investment opportunity without being rattled by prior losses.

So, what conclusions are we to reach from this?  Were successful contrarian investors like Warren Buffett dropped on their heads as babies?  Should we lobotomize all money managers to improve their performance?

Ah, if it were only that simple.  As O’Shaughnessy writes, “our brains are wired the way they are for very good reasons… Indeed brain damaged patients like those in Shiv’s study often went bankrupt because a lack of emotional judgment made them too risk-seeking and susceptible to scams.”

Science has not yet created a “switch” to flip that will turn us into perfectly rational investors.  Alas, the burden of emotional control lies with us.  When you feel your heart racing, either in euphoric anticipation of profit or paralyzing fear of loss, you have to step back and consider the numbers dispassionately.

With all of this said, what are investors to make of today’s market?

Yes, the market has had a nice run of late, and the S&P 500 is close to hitting its old high. Yet equity mutual funds bled over $19 billion in redemptions in August, the last month for which data is available.  This was the sixth month in a row in which investors pulled their money out, and the 14th month out of the last 16 (see “Mutual Fund Outflow Soared in August”).

Meanwhile, bond funds have seen net inflows for the past 12 consecutive months.  Yes, the same bond funds that are buying 10-year Treasuries at 1.6% yields—well below the rate of inflation.

After the 2008 meltdown, the 2010 Flash Crash, and the past two years of “on again / off again” sovereign debt crisis in Europe, investors have dug themselves into a bunker.  Having been burned, they are reluctant to touch that hot stove we know as the stock market again.

For those of us willing to look at the numbers—or perhaps those of us suffering from brain damage—there is ample upside left in this market.  At 14 times earnings, stocks (as measured by the S&P 500) can hardly be considered expensive.  And when compared to bonds yielding significantly less than the rate of inflation, stocks would appear outright cheap.  With prices reasonable and individual investors having already largely fled equities, it’s hard to see the conditions for a sustained bear market.

But even if macro concerns of excessive investor pessimism keep a lid on stock prices in the months ahead, dividend paying stocks offer respectable cash payouts that are close to as safe as bond yields.  According to Standard & Poor’s, the stocks of the S&P 500 currently pay out only 30% of their earnings as dividends.  It is difficult to see widespread dividend cuts coming from such low levels.

This is the focus of Sizemore Capital’s Dividend Growth Portfolio.  At current prices, I believe a portfolio of dividend-paying stocks, REITs, and MLPs with high and rising cash payouts is the most sensible option for most investors.  But then, there might be something wrong with my amygdala.

This article originally appeared on MarketWatch.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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What Does the Smart Money See for the 4th Quarter?

There is an art to following the recommendations of Wall Street strategists.  Taken individually, the average strategist tends to be pretty sharp.  They do their homework, they have well-funded research teams, and it can be worthwhile to hear what they have to say, even if their advice tends to be very conventional.

But whatever value there is in listening to an individual strategist, you can get an entirely different layer of insight from seeing what they have to say as a group.

This is not to say you should blindly follow the advice of Wall Street strategist, and as often as not you can even use them as a contrarian indicator and bet against them.

Like all investors, top strategists can be prone to certain psychological biases.    They tend to “anchor and adjust” their existing forecasts, which means they fail to fully react to new information.  They fall victim to a “recency bias” in that they tend to place undue importance on recent events while ignoring the long-term historical record.  They are prone to “confirmation bias,” meaning they look for data that confirms their current view rather than keeping an open mind and letting the data guide their opinions.

And perhaps most of all, they can be prone to herding behavior.  We humans crave the approval of others, and we often think and act as a group rather than as independent-thinking individuals.  It’s during times like these that the smart money doesn’t look all that smart.

With all of that as a introduction, let’s see what the smart money expects for the remainder of 2012.  In the September 3 issue, Barron’s interviewed 10 prominent Wall Street strategists to get their predictions on GDP growth, the 10-year Treasury yield, and the level of the S&P 500.  Barron’s also asked each strategist to give their favorite sectors and the sectors they’d recommend avoiding.

The opinions were in a fairly tight band.  7 of 10 analysts were bullish, though their forecasts hardly made them wide-eyed optimists.  Year-end estimates for the S&P 500 ranged from 1167 on the low end—a  nearly 20% decline from current levels—to 1480, which is a just a modest 3% above current prices.  (The poll was taken before the large run-up of the past few weeks, but the forecasted gains would still seem pretty subdued.)

Forecasts for the 10-year Treasury yield ranged from 1.5% to 2.4% with an even 2.0 percent being the most common answer.

Given that the 10-year yields 1.57% at time of writing, the strategists would seem to be putting out mixed signals.  They see an economy strong enough to send Treasury yields up by nearly a quarter, yet they see only modest stock market gains.  It’s hard to see both of these forecast being correct.

The sector choices tell an interesting story as well.  Fully half of the strategists recommended technology, which is high but not out of line for this group, while one recommended avoiding it (and the one strategist that recommended avoiding it was only bearish on software; he was actually bullish on hardware).  Technology has been highly recommended for a couple years now, and I wouldn’t see this as a sign of rampant herding.

Healthcare and energy were also popular choices, getting four votes each.

On the bearish side, no one sector was singled out by the group.  Materials received the highest number of “nays” at four, but I would hardly consider that a consensus.  Bearish sentiment was pretty evenly distributed across sectors.

Overall, there are no obvious conclusions to be gleaned from the smart money this go around.  They seem as muddled and confused as the rest of the investing public.  If anything, a contrarian might take a look at their lack of strong conviction and see it as a bullish signal to tack on a little risk for the last quarter.

This article first appeared on MarketWatch.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Zynga: When You Lose Control of Your Emotions, It’s Time to Stop Trading

One evening two years ago, I logged in to Facebook ($FB) to upload new photos of my son (if memory serves, he was bouncing in a Jumperoo) and I got an announcement that John had just planted corn on some videogame I had never heard of. 

Why anyone would have found that piece of information interesting was beyond my comprehension, but before I finished uploading my photos I had received no fewer than nine other status updates.  James milked a cow.  Irene made plum wine.  Kate built a barn.  And all of them were requesting that I join them on Farmville. 

In the weeks that followed, I changed my Facebook settings multiple times to block the status updates, but they somehow found a way to keep coming.  It was a losing battle.  I finally succeeded in blocking Farmville, but then I started getting invites for CastleVille and CityVille.  Susan just built a skyscraper.  Great.

I defriended the worst offenders and changed my settings…again.  And yet they still kept coming. 

When I found myself fantasizing about committing horrendous acts of violence against the makers of these videogames, I decided it was best for my mental health to quit using Facebook altogether. 

I tell this story for a reason.  My blind hatred of Zynga ($ZNGA) and its games made trading the stock a bad idea.  Yes, I missed a great short opportunity, but sitting this one out was the right thing for me to do.  When you lose emotional control, you lose objectivity.  And there is no faster way to ruin yourself in the capital markets. 

Fear and greed drive markets, but don’t forget how powerful an emotion hate can be as well.  When you are able to maintain emotional detachment—embracing your inner Spock, if you will—you can trade the emotional impulses of others in a contrarian strategy.  But when you find yourself legitimately hating a stock as if it were an old enemy with whom you have a blood feud, you’re no longer thinking rationally.  You’re not looking at the numbers, and you’re setting yourself up for failure. 

Think about talented short sellers you have met, traders who have been in the business a long time.  You will never hear them say things like “I hate this stock” or “I want this to fall.”  They keep a level head and stick to their trading rules, or they don’t survive long in that business.

Emotional detachment is equally important on the long side, of course.  I consider Peter Lynch’s advice to “buy what you know” to be some of the most dangerous advice ever given because it requires a level of emotional control that so very few people have.   The fact that your neighborhood Starbucks ($SBUX) is your favorite hangout doesn’t make a good or bad investment, but it can cause you to lose your objectivity. 

To be sure, an investor can learn a lot by visiting local stores. But you have to make a herculean mental effort to prevent anecdotal data  from feeding a confirmation bias that essentially tells you what you want to hear.  If you’re already a Starbucks bull, you might notice that the lines seem longer than usual but fail to notice that customers have traded down from venti size to tall, and vice versa for a Starbucks bear. 

Returning to the theme of hatred, we should also consider the peculiar case of sin stocks and particularly tobacco stocks.  I don’t know that there has ever been a more despised industry in history.  But investors who hate tobacco for personal reasons or avoid it due to moral qualms create trading opportunities for the rest of us. 

The historic tobacco stock underpricing has gone into reverse this year, and Big Tobacco giants like Altria ($MO) and Philip Morris ($PM) are among the best performing.  Whether this is simply a temporary phenomenon created by the current low interest rate environment remains to be seen, but the behavior of sin stocks is still something that every investor should study (see “The Price of Sin“). 

I’ll finish this with a confession.  After writing several hundred words in this article about the need for emotional control, I still hate FarmVille.  Just writing the word brings a sneer to my face and causes my heart rate to rise.

I have no business trading Zynga stock. 

 Disclosures: Sizemore Capital is long MO.

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Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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