Investors should be familiar with price volatility and be prepared for the losses and psychological impact it can cause.
In the world of investing, price volatility can be a source of fear, but it can also be a window of opportunity. There are two main ways to capitalize on it: timing and price selection. Understanding these two strategies and applying them correctly can be the key to your investment success.
Timing the market is a strategy that involves predicting where a stock price will go and buying or selling a
stock at that point. For example, if an investor predicts that the stock market is about to rise, he or she
will try to buy stocks before then to take advantage of the price increase.
Conversely, if the market is
expected to fall, he or she will try to sell stocks early to cut losses or take profits. This method is
based on the assumption that the market's movements can be accurately predicted. However, predicting the
market is very difficult, and is sometimes more like speculation based on luck.
| Reasons | Description |
|---|---|
| Markets are unpredictable |
The stock market is influenced by many variables, including economic conditions, political events, natural disasters, changes in company performance, and other unpredictable factors. These variables interact in complex ways. |
| Markets are influenced by emotions |
Emotional factors such as investors' expectations, fears, and greed strongly influence market prices. These emotions do not follow logical or predictable patterns. |
| Accuracy of timing |
It is almost impossible to accurately predict market peaks and troughs. Buying or selling at the wrong time can have the opposite effect than expected. |
| Investor | Aphorism |
|---|---|
| Warren Buffett | "Trying to predict the market is gambling. Rather than trying to time the market, the key to success is to buy shares of good companies at a reasonable price and hold them for a long time." |
| Peter Lynch | "Instead of trying to predict the direction of the market, you should focus on individual companies. Invest in companies based on their fundamental value and growth potential." |
| Benjamin Graham | "It's dangerous to focus on short-term market movements. It is wise to take a long-term view, focus on the intrinsic value of a company, and buy when the price falls below the intrinsic value." |
These aphorisms emphasize the importance of company value, taking a long-term view, and investing consistently rather than market timing. Even amidst market uncertainty, adhering to these principles can lead to successful investing over the long term.
Price selection is a strategy that involves buying when a stock price is below what investors believe is
a fair price and selling when it is above. It capitalizes on the difference between a company's
fundamental value and its market price.
For example, if you believe that a company's stock is
significantly undervalued compared to its true value, you buy it. Then, when the market recognizes its
value, the stock price rises, at which point you sell it for a profit. This strategy takes advantage of
the discrepancy between a company's intrinsic value and its market price, and it takes a long-term
perspective.
A pricing the market strategy takes advantage of the discrepancy between a company's intrinsic value and its market price. It involves carefully analyzing a company's fundamental value, buying when the market price is undervalued relative to that value, and selling when the market recognizes the company's true value and the price rises. This approach can yield favorable results for investors over the long term.
Behavioral economics is the study of human irrational behavior patterns and the impact of psychological factors on economic decisions. The reasons why famous investors recommend price selection strategies are based on the following behavioral economics factors:
| Behavioral Economics Factors | Description |
|---|---|
| 1. Market overreaction |
Investors often overreact to short-term news or events, overbidding or overselling a stock. This causes stock prices to temporarily misalign with a company's true value. Price selection strategies capitalize on these market overreactions to identify and invest in undervalued stocks. |
| 2. Investor bias |
Humans are susceptible to a variety of cognitive biases, including confirmation bias, overconfidence, and representativeness bias. These biases distort investment decisions, causing market prices to misalign with a company's intrinsic value. Price selection strategies allow investors to avoid these biases and make decisions based on cold analysis. |
| 3. Market Herd Mentality |
Investors are often influenced by herd mentality to do what everyone else is doing, which sometimes leads to irrational price formation in the market. A price selection strategy breaks away from this herd mentality and uses independent valuation to make investment decisions. |
Renowned investors understand that these behavioral economics factors can lead to irrational price formation in the market. They use price selection strategies to exploit this irrationality for long-term gains. This strategy requires deep analysis, patience, and a dispassionate approach to investing, but in the end, it's a powerful way to turn market irrationality to your advantage.
In Benjamin Graham's "The Intelligent Investor," he places particular emphasis on price selection. Rather than trying to predict short-term market movements, Graham suggests focusing on a company's intrinsic value and seeking undervalued stocks. This reduces investment risk and generates stable returns over the long term.
In early 2020, the COVID-19 pandemic hit the world, causing a major shock to the economy and markets. Many investors were concerned about the long-term impact of the pandemic on the global economy and expected a massive decline in the stock market. In response, some decided to rush to sell their stocks, which seemed like a wise choice at the time.
However, markets began to rebound quickly and unexpectedly, with some stocks, particularly technology stocks, surpassing their pre-pandemic levels in value. This recovery was unforeseen by even many analysts, and investors who sold their stocks early missed out on huge gains in the subsequent bull market, even if they avoided initial losses.
Nvidia's stock price dropped significantly in late 2018 and early 2019 due to a number of external factors. However, investors who recognized the company's strong position in future technologies such as AI, deep learning, and autonomous vehicles saw this as a buying opportunity.
They dug deep into Nvidia's financials and growth prospects, decided to buy when the stock price was down, witnessed Nvidia's continued growth over time, and reaped the rewards when the stock price rose again. Nvidia's story illustrates how a price selection strategy can work in an investor's favor over the long term, and emphasizes the importance of staying on top of technological advances and market changes.
The "buy low, sell high" technique seems simple on the surface: buy when a stock price falls below its intrinsic value in a bear market, and sell when the stock price exceeds its intrinsic value in a bull market. The key to this technique is to take advantage of stock price volatility that results from market overreaction.
Benjamin Graham sees this technique as more than just predicting market cycles. He calculates the intrinsic value of a stock and only invests when the stock is undervalued relative to that value. Graham introduced the concept of a "margin of safety" to do this. A margin of safety is the difference between the market price of a stock and its calculated intrinsic value, which serves to reduce the risk of an investment.
Graham acknowledged market cycles, but was wary of strategies that relied on predicting them. He believed
that while it was important to understand and take advantage of market volatility, investing that relied on
market timing was ultimately risky.
As such, he recommended a strategy of rebalancing stocks and bonds
regardless of whether they were in a bull or bear market - reducing the allocation to stocks in bull markets
and increasing the allocation to stocks in bear markets - to prepare for market volatility and ensure
long-term stability.
| Market Cycle Example | Description |
|---|---|
| Bull Market Cycle after a Bear Market |
The recovery after the 2008-2009 financial crisis: The 2008 financial crisis resulted in a global bear market, which took a toll on the stock market. However, the bull market that began in 2009 recovered previous losses and took the market to higher levels than before. Investors who bought at bargain prices were able to make big gains during this period. |
| Periods when the cycle didn't work out |
The dot-com bubble burst in the early 2000s: In the early 2000s, the market experienced a sharp decline with the bursting of the dot-com bubble. During this period, many technology stocks lost significant value, and the market did not recover in a short period of time. This deviated from the traditional bear market followed by a bull market cycle, and reminded investors of the uncertainty and unpredictability of the market. |
These two periods illustrate the different aspects of market cycles and highlight the importance of
understanding market volatility and cycles in particular.
However, by following Benjamin Graham's advice and adopting a strategy of not trying to time the market, but
rather rebalancing your investment portfolio as market conditions dictate, investors can promote long-term
stability. This can be an effective way to seek consistent returns even through uncertain market cycles.
Investing by formula is a strategy in which you mechanically sell a portion of your holdings when stock prices rise. This method aims to capitalize on the upturn in stock prices to realize a profit. Initially, this strategy seemed to promise reasonable and consistent returns.
However, in the mid-1950s, investors who applied this strategy experienced some of the worst performance ever. At the time, the market was experiencing a strong bull market and stock prices continued to rise. In these market conditions, the formula sell strategy resulted in lost profit opportunities rather than maximizing profits.
A classic example of how formulaic investing strategies have become commonplace is the "magic formula". This strategy was introduced in Joel Greenblatt's "The Little Book of Stock Market Beating". The formula is a simple but effective way to pick stocks based on a company's earnings and profitability, specifically aiming to buy companies that are likely to generate high returns at low prices.
The Magic Formula, introduced by Joel Greenblatt, is a simple but effective strategy for picking stocks based on earnings yield and return on capital.
The formula investing method was once a revolutionary strategy in the investment world. At its core, it involves evaluating companies and making investment decisions based on two key metrics: Return on Capital and Price to Earnings Yield. This approach promised high returns to investors, and initially produced many success stories.
| Metric | Description |
|---|---|
| Return on Capital | This metric measures how efficiently a company uses its capital to generate profits. A high number indicates that the company is utilizing its resources well. |
| Price to Earnings Yield | This is an indicator of a company's profitability relative to the price of its stock. It shows how undervalued the stock is relative to its current market price. |
But as the formula became more popular, things started to change. As more investors adopted the strategy, demand for stocks selected by the same criteria skyrocketed, driving up the prices of those stocks and making it harder to realize the formula's principle of investing in companies with high yields at low prices.
In addition, the competitive advantage in the market was lost as many investors selected stocks based on the same criteria, making it harder to earn excess returns. As a result, the magic formula went from being an innovative strategy in its early days to being seen as a mediocre one.
The principles of the magic formula are still valid, but their effectiveness has diminished somewhat due to
changes in the market environment and the popularization of the strategy.
It is important for investors to be aware of these changes and to combine individual analysis with a wider
variety of strategies. After all,
in the world of investing, flexibility and continuous learning are the keys to success.
Market volatility is an unavoidable reality of stock investing. Sometimes, the market's sharp movements shake
investors to their core, which is especially challenging for beginners who lack investment experience.
However, despite this market uncertainty, we can learn how to build a solid stock portfolio based on the
maxims of famous investors such as Benjamin Graham, Warren Buffett, and Peter Lynch. This will help you
create a stable investment strategy that won't be swayed by market fluctuations.
| Investor | Maxim |
|---|---|
| Benjamin Graham | Value Investing - Buy undervalued stocks |
| Warren Buffett | Long-term Investing - Focus on quality companies with enduring competitive advantages |
| Peter Lynch | Invest in what you know - Invest in companies you understand and believe in |
In a volatile market environment, a balance between stocks and bonds is crucial. While stocks can offer
potentially high returns, they can also be highly volatile. Bonds, on the other hand, offer relatively
stable returns and can be a good defense against market volatility.
Graham recommends selling some
stocks
when the market is rising and using the proceeds to buy bonds. Conversely, when the market is down, he
advises selling bonds to buy stocks. Strategies like this help investors make more objective and rational
investment decisions without getting swept up in the volatility of the market.
| Investment Strategy | Action |
|---|---|
| During Market Uptrend | Sell some stocks and buy bonds |
| During Market Downtrend | Sell bonds and buy stocks |
There are tons of stocks in the market, and their prices are always fluctuating, so investing all your money
in one stock is a very risky strategy.
By investing in a variety of blue-chip stocks with sound
financials
and high growth potential, you can effectively spread this risk. This way, you can minimize the impact of a
particular stock's performance on your overall investment portfolio, and you can expect more stable returns
in the long run.
| Strategy | Advantages |
|---|---|
| Diversify Portfolio | Minimize risk, more stable returns |
| Invest in Blue-chip Stocks | Sound financials, high growth potential |
Successful investing starts with the right mindset. When markets are volatile, it's important to take a step
back and objectively analyze the big picture rather than rushing to make investment decisions. Peter Lynch
advises investors to have their own investment philosophy and base their investment decisions on that.
This will help you invest with a long-term perspective and not be swayed by short-term fluctuations
in the
market. He also emphasizes the importance of investing in areas that you understand and can analyze. This
will help you avoid unnecessary risks and create a clearer investment strategy.
| Advice | Benefits |
|---|---|
| Develop your own investment philosophy | Long-term perspective, avoid short-term fluctuations |
| Invest in areas you understand | Avoid unnecessary risks, clearer investment strategy |
Investing with a long-term perspective is key to successful investing. Many investors are unsettled by
short-term market fluctuations, which can lead them to make poor decisions.
However, successful
investors
like Warren Buffett emphasize the importance of maintaining a long-term perspective and not being swayed by
short-term market fluctuations. By being patient and investing in stocks that have long-term value, you can
experience the growth of your wealth over time.
| Key Principle | Benefits |
|---|---|
| Long-Term Perspective | Stability, avoiding poor decisions, wealth growth over time |
| Factors | Description |
|---|---|
| Exceeding Expectations | Successful companies often show profitability and growth rates that exceed expectations, justifying a higher stock price. |
| Future Growth Prospects | Investors don't just look at current performance; they also place a high value on potential future
value and growth. Successful companies offer the prospect of continued growth through innovation , expanding market share, and exploring new markets, and this prospect is a major factor in placing a premium on their stock price. |
| Market Psychology | The stock market is not just a reflection of numbers and data, but also a reflection of investor sentiment and expectations. Positive news about a successful company, favorable analyst ratings, and a good reputation within an industry can all contribute to a stock price increase. |
| Competitive Advantage | Companies with sustainable competitive advantages are more likely to generate high returns over the long term.Unique technologies, strong brands, and efficient operations give these companies an edge in the market, which positively impacts their stock price. |
| Investor Following | Successful companies attract the attention of many investors, which results in an influx of funds. When large investors and institutional investors invest in these companies, the stock price tends to rise further. |
These factors combine to create a premium for the shares of successful companies. However, investors should
always carefully evaluate whether the heightened expectations and premiums are in line with the actual
intrinsic value of the company.
This will help them avoid overvalued stocks and seek stable returns
over
the
long term.
Defensive investors are those who seek stable returns despite market volatility. They specifically favor stocks whose share prices haven't deviated too far from their tangible value (UV). Why is that?
Tangible asset value is the value of the physical assets a company owns. It is based on the value of a company's physical assets, such as real estate, machinery, and equipment. If the stock price does not deviate too far from this tangible asset value, the stock is trading close to its intrinsic value.
| Reason | Explanation |
|---|---|
| Finding undervalued stocks | Stocks close to their tangible asset value are often undervalued, presenting an opportunity for higher returns over the long term. |
| Stability | Companies with substantial tangible assets tend to maintain relatively stable profitability despite economic fluctuations, appealing to defensive investors seeking stability. |
| Low investment risk | Stocks not deviating much from tangible asset value typically pose lower risk of sharp price drops, enhancing investment stability. |
| Strategy | Explanation |
|---|---|
| Financial analysis | Analyze a company's financial statements to identify its tangible assets and their value. This helps understand the intrinsic value of a company and assess how undervalued its stock price is relative to them. |
| Investing for the long term | Investing based on tangible asset value aims for long-term stability and growth, prioritizing patience and a focus on long-term gains over short-term returns. |
| Analyze diverse companies | It's crucial to analyze various industries and companies to find undervalued stocks with high P/E ratios. Diversification across different sectors helps manage risk in the investment portfolio. |
A&P, or Great Atlantic and Pacific Tea, is the largest retail company in the United States, having been
listed on the stock market in 1929, where its stock price once soared to $494. However, in 1932, the stock
price plummeted to 104, and in 1936, it fluctuated between 111 and 131.
What's more, in the 1938
crash, the
stock price dropped to a new low of 36. Despite these extreme stock price fluctuations, A&P was still a
successful company that generated huge profits.
| Point | Explanation |
|---|---|
| Market capitalization | At the time, A&P had a market capitalization of $126 million, $85 million in cash, and $134 million in net current assets, indicating it was not a failed company. |
| Causes of undervaluation | The undervaluation of A&P stock was mainly due to concerns about a potential special tax on chain stores, which was exaggerated, and a temporary decline in net income coupled with a market downturn. |
| Behavior of a true investor | A true investor would not have been swayed by temporary concerns or market fears but would have recognized the intrinsic value and made a bold investment decision. The A&P case demonstrates the importance of considering stock market volatility in investment decisions. |
| Mr. Market Fable | Mr. Market is depicted as a highly emotional figure, offering to sell a stake in a company at a low price one day and buying it at an excessively high price the next. This reflects the wild fluctuations in stock market prices driven by external factors and emotions. |
|---|---|
| Investment Principle | Investors should not rely on Mr. Market's price offers. Instead, they should evaluate the true value of the companies they invest in and make decisions with a long-term perspective, focusing on intrinsic value and growth potential rather than short-term market volatility. |
| Warren Buffett's Adage | "Be greedy when the market is afraid, and fearful when the market is greedy." Buffett emphasizes the importance of understanding a company's intrinsic value and investing when that value exceeds the market price, regardless of market sentiment. |
| Key Takeaway | The Mr. Market fable and Buffett's adage underscore the significance of maintaining psychological stability, focusing on long-term value investing, and not being swayed by short-term market fluctuations. |
The strategy of waiting for a stock price to bottom before buying may seem attractive in theory. In practice,
however, it's nearly impossible to accurately predict the bottom of a stock price, and this can cause
investors to miss out on good investment opportunities.
In Benjamin Graham's view, the important
thing is
not to try to predict the bottom of a stock price, but to understand the intrinsic value of a company and
determine whether the stock price is reasonable relative to that value.
Why not wait for the stock price to bottom?
| Point | Description |
|---|---|
| The difficulty of market timing | There is no surefire way to know whether a stock price has bottomed or not. Attempts to predict market timing often end in failure, which can cause investors to miss better buying opportunities. |
| Opportunity cost | While holding off on investing due to the expectation that the stock price will go lower, investors may miss out on other lucrative investment opportunities. They also miss out on income, such as dividends, that can be earned by holding shares in good companies. |
| The value of long-term investing | Benjamin Graham emphasizes focusing on long-term value rather than short-term market volatility. Over the long term, stocks of good companies are likely to increase in value over time. |
| Point | Description |
|---|---|
| Time value of money | The value of money gradually decreases over time. Therefore, if you wait too long, the gap between intrinsic value and stock price will decrease and you may miss the opportunity. |
| Opportunity cost | While waiting, a company's value may be reflected in the market, which means that investors may be forced to buy shares at a higher price or miss out on better companies. |
| Uncertainty in the market | The market is full of uncertainty, and stock prices can fluctuate due to unpredictable external factors. Therefore, if you wait too long, your investment decision may be driven by the volatility of the market rather than the value of the company. |
| Growth of the company | Companies can grow over time. If you wait too long, you may miss out on a company's growth potential and give up future profits. |
Therefore, when following a value investing philosophy based on a company's intrinsic value, it is important
to buy at the right time when you believe a company is undervalued.
Waiting too long can result in
opportunity costs and loss of time value of money, and market uncertainty can cause even greater losses.
According to Benjamin Graham's investment philosophy, there can be a direct relationship between stock prices
and the ability of managers, but it is important to recognize that short-term stock price movements do not
always correspond to the intrinsic value of a company.
Graham emphasizes that investors make
investment
decisions based on the intrinsic value of a company. However, over the long term, good managers can drive
stock prices higher by making decisions that increase the intrinsic value of a company.
| Factor | Description |
|---|---|
| Vision and Execution | Great managers set a long-term vision for the company and develop strategies to put it into action. This fuels the company's growth and increases shareholder value over the long term. |
| Financial Strength Management | Managers maintain the company's financial strength through efficient capital management, which gives investors confidence and supports the stock price. |
| Transparent Communication | Transparent communication with investors builds trust and increases understanding of the company's strategy and performance, which positively impacts the stock price. |
| CEO | Company | Leadership Impact | Stock Price Growth |
|---|---|---|---|
| Warren Buffett | Berkshire Hathaway | Warren Buffett is a protégé of Benjamin Graham and is a prime example of someone who has applied his
investment philosophy to real-world management. Buffett focused on intrinsic value analysis in his investments and management, focusing on increasing the value of his company over the long term. Under his leadership, Berkshire Hathaway's stock price has increased by 2,744,062%, proving that he is a great manager. |
2,744,062% |
| Steve Jobs | Apple | Steve Jobs is the man who transformed Apple into a symbol of innovation. He had a
revolutionary
vision for product development and a clear strategy to make it a reality. Under Jobs' leadership, Apple launched several innovative products and led the market, which led to a 4,694% increase in Apple's stock price. |
4,694% |
| Jeff Bezos | Amazon | Jeff Bezos is the man who grew Amazon from an online bookstore to the world's largest online
retailer. Bezos' customer-centric business strategy, constant innovation, and
expansion into various
business sectors has made Amazon a leader not only in e-commerce, but also in cloud computing,
artificial intelligence, and other technologies. This strategy has boosted Amazon's stock price by 164,125% and established Bezos as one of the most successful executives in history. |
164,125% |
| Elon Musk | Tesla, SpaceX | Elon Musk is the CEO of electric car company Tesla and space exploration company SpaceX, and is
known for his bold vision for the future of technology. Under Musk's leadership,
Tesla has
revolutionized the electric vehicle industry and become one of the world's most valuable
automakers. SpaceX has also revolutionized the space industry, developing reusable rocket technology that has dramatically lowered the cost of space exploration. Musk's innovative approach has led to a 17,500% increase in Tesla's stock price. |
17,500% |
| Sandra Pichai | Google (Alphabet) | As CEO of Google, Sandra Pichai has led the growth and innovation of key products including Google
Search, Android, Chrome, and Google Cloud. Under her leadership, Google is also pioneering
future
technologies such as artificial intelligence, machine learning, and self-driving
cars. This innovation and growth has led to a 272% increase in the stock price of Google's parent company, Alphabet. |
272% |
| Satya Nadella | Microsoft | Since Satya Nadella took over as CEO, Microsoft has seen incredible growth in cloud
computing. Under
Nadella's leadership, the company has significantly expanded its cloud service, Azure, which has
become one of the company's main revenue streams. Nadella has also focused on digital transformation, artificial intelligence, and sustainable technology development, which has led to a 585% increase in Microsoft's stock price. |
585% |