Lessons from a Market wizard

For those that know me, you know that I am an avid reader of market related books and newspaper articles.

Last week I came across an article in the Australian Financial Review called “Wizards of the Game”. The Financial Review interviewed some of Australia’s most respected and high profile fund managers and their individual approach to investment.

I specifically enjoyed reading the thoughts of Kerr Neilson, managing director of Platinum Asset. Mr Neilson spoke of the challenges that fund mangers and investors alike are presented with when investing in the market.

I wholeheartedly agree with many of Mr Neilson’s comments, but how can the problems we all face be solved?

I’ve done my best to dissect Mr Neilson’s comments before outlining how I counter balance the issues we all face.

My responses to this article will take part this week and next. I hope you enjoy the read.

Kerr Neilson, managing director and founder, Platinum Asset Management

“Psychological conditioning hinders interaction with the stock market. The mind uses short cuts in all aspects of the collection, weighting and interpretation of “facts”, so by being wary of our instinctive behaviour we are more likely to avoid common pitfalls.”

[GS] Almost every active investor undervalues the effect psychology plays with active investment.

The sooner you realise that you are trained to survive in society and not in the market, the sooner you can put steps in place to gather the knowledge you need to achieve success in the markets. Engaging the stock market as either a trader or an investor is just as much about mastering yourself as it is mastering the market. For most of us this involves learning to think from the perspective of the market rather than the ‘normal’ societal paradigms we use in our everyday life. Some of these include replacing the need to be right with an acceptance of losing, buying when a stock price is rising and going higher rather than trying to buy ‘cheap’ when the price is falling, and so on.

Personally, for those interested in improving their trading psychology I would recommend Mark Douglas’s best selling book, “Trading in the Zone”.

I often say to investors who buy Mark’s book, don’t read it, STUDY IT!

“Availability bias is one of the most common influences on our decisions. When there’s a lot of news coverage of a company, if it’s good it tends to drive more enthusiasm; but when negative, it tends to reinforce the negativity.

You see that quite often and then link that in with selective choice of information. If it happens to be in the wrong place – for example, an emerging market which is out of favour – then they almost double up on the negatives.

Whatever is on the front page is already priced and should probably largely be set aside and not given 100 per cent focus – it really is not a driver of the stock at the time.”

[GS] I agree with Mr Neilson that by the time a stock hits the headlines everything that is known and unknown is already built into the stock’s price. By using a technically based system that identifies opportunities in the market based on price action, we are able to overcome the effects of ‘noise’ generated from the financial media and other sources. By avoiding the opinions and noise of others who, on the whole, have biases and prejudices, we are able to stick to our rules of engagement from a neutral perspective and without the interference of outside influences.

As a user of the SPA3 system, the aim is to be an early adopter of the trend which relies on the timing of price movements in the market.

“Another thing we all do, particularly private investors, is anchoring. This is when investors form a position and grasp a fixed point of reference – for example, making it an aim to get back the price they paid. If a thing was worth $20 last week, why is it now only worth $15? They think that’s relevant in their trading but often the market just got too excited.”

[GS] By doing this, investors are forward projecting their expectations onto a position they have in a stock and, coupled with their ingrained need to be ‘right’ will tend to lose their objectivity when the position moves against them and becomes a losing trade. No-one sets out to buy a stock in the expectation that the price will fall, but when it does they must learn to let go of the position, accept that it is indeed wrong, cut their losses and move on to the next opportunity.

This is achieved by having a neutral mindset that does not ‘anchor’. A neutral mindset is achieved by believing Mark Douglas’s Five Fundamental Truths at your core and then practicing them in live trading situations.

Next week I will have some more responses to Kerr Nelson’s comments.