Worried? Because don’t have right investment methodology

Liam Zhou   2019-05-18 本文章174阅读

When the market is weak, many stock buyers are worried. 

Escalating trade war (between US and China) bring the market down. Since everyone try to predict market movement even unconsciously, when we see the market going down, distinction tell us it will continue the trend and incur loss,that making people anxious.   

Free ourselves from the initial reaction and think again carefully, if we should worry. Firstly, ask yourself a question: can you predict the market ups and downs that worries you.

On the 1 May, who foresaw the big drop on 6 May. Early on, who predicted the up run of first quarter at the beginning of this year. Whether from fundamental or technical aspect, its very hard to predict the market movement.

Why the market is so unpredictable? Because the events/factors making the movement of tomorrow’s market are unknown today, what happened in the past, already reflected in the stock price. 

On 1 May, you didn’t know Trump would raise the Tariff. On 1 January, you didn’t know the adjusting of regulatory approaches. At beginning of last year, you wouldn’t know the trade war is breaking out. Those future events, dominating the market future movement. Most predictions are wrong, whether its market or individual stock movement prediction.

Since its almost impossible to predict market, really no need to waste our emotions on market ups and downs. 

But many investors believe market can be predicted, and need right prediction to bring return. Spending months, years of time and energy on market prediction, brings little positive result. This is a misunderstanding widely exist.

Your predictions are no much different to others, and the current stock price already included expectation of the majority investors.

Market fluctuates everyday to reflect the changing expectation. Current price is a collective view of most investors. If your expectation/prediction is similar to the market majority, the investment result would be similar too. In stock market, is the majority making or losing money? The majority investors not achieving excess return, not even the average return of the market such as major index. Our target is to make excess return on active stock investment, otherwise just need to buy index.

How to get excess return, since market prediction is not reliable at all.

The theory of Behavioral Finance becoming popular recent years, it reveals irrational behaviors caused by misunderstanding, misjudgment and extreme sentiment that most investors encountered, which echos what we observed in China market over the years. In second quarter 2015, the market reached a risky high place, most people rush in to buy stocks with overoptimism. Whereas end of 2018, market at its low point, most people worried about black swan events, selling stocks and kept away from market. Although investors received similar information, but everyone can have their own understanding, interpenetration and judgment. When majority bias appears, stocks can be mis-priced, that is the source of excess return/Alpha. 

In one sentence: Alpha from bias of the majority.    

Study possible bias in the mainstream views, rather than worry about market movement.

Based on accessible information to identify the area that majority misunderstanding, misjudgment and extreme sentiment exist, find bias/mistakes of majority’s investment decision, spot mis-priced stocks, enable us to achieve excess return, that is what we should focus on.  

Behavioral Finance discovering most common area that people have cognitive bias.

Investors easily have bias like:Anchoring, Herd Behavior,Hindsight bias, overconfidence etc. Finding bias requires critical thinking, innovative research.

Lets do a small test: according to 2018 China mutual fund annual reports, PingAn is the most invested stock in terms of investment amount. Is PingAn been overweighted by China mutual funds?

 The first thought could be: PingAn has been overweighted by mutual funds with high concentration. Everyone can do the calculation to find out the actual mutual funds allocation for PingAn from the public data of about 2000 active equity mutual funds in China. The result will tell you how easily people can make conclusion without sensible verification. In the opposite, PingAn is not overweighted, but well underweighted. (As you may know PingAn reached historical high in 2019.)

Alpha from bias of the majority. When most people making mistakes, its the time to make money in stock market, and often those opportunities are ignored by the majority.