The Value of the Time Out

In the words of Dick Vitale... "Get a T.O., Baby!!"

The value of the time out to the investor and investors plural (i.e., "the market") is hard to exaggerate.

Whether it's FDR's famous "Bank Holidays," or suspended trading, or simply going for a long walk when you're tempted to make an impulsive trade, the "time out" is a major weapon in an investor's fear-fighting aresenal.

Why? Because fear FORCES us to think short term. It's simply the way our brains are wired. There is a sound biological/evolutionary reason behind this reaction.

When you're out gathering firewood for the cave and lock eyes with a large male Smilodon (read Sabretooth Tiger) who has just emerged from the glade, your brain simply CANNOT LET you indulge in thoughts like "what to wear to Zog's birthday party?" or "should I redo the cave paintings for the harvest season (antelopes are so "early pleistocene")?"

The Sabretooth has gone the way of the Dodo, but the evolutionary function remains. Intense fear still draws our focus on the here and now. As well it should.

This is where the time out can help. The ablility to take a break and regain our bearings (to "step out of the box" as Crash Davis would say) gives our amydalas a chance to stop firing. When that happens we can engage other parts of our brain. That's when we can pull up and out of the tailspin of panic. It's neurobiology. See Rich's critically acclained tome for more information.

This is, of course, the eternal struggle for investors: To pull out of the short-term focus and think big picture.

When we do calm our brains and revisit the situation, it doesn't mean our outlook becomes rosy. It just means we've given our brains the ability to reintroduce reason to our thinking processes - and perhaps a chance to spot the fantastic opportunities such crises produce.

A few days off may be just what the doctor ordered.

In the meantime, good luck out there, everyone.

Frank

Pressure Valve: Letting off Steam

Have you ever seen a steam pipe explode?

I did. I was in Boston driving down Boylston. I heard an explosion, checked the rear view mirror and what I saw looked amazingly close to the above photograph.

Market crises can create the investing equivalent of steam pipe explosions. Investors get caught between two competing pyschological forces that build up pressure:

On one hand, uncertainty causes indecision.

But on the other hand, when we are anxious, we naturally feel a need to do SOMETHING.

The result of these two psychological forces work against each other until -- Kaboom! -- the pressure becomes too much.

It's a vicious cycle and it goes something like this: Do nothing (and suffer), do nothing (suffer some more), continue to do nothing (suffer to the breaking point) then PANIC!!! (do something rash).

It's a wealth killer.

We need a way to let off steam, so that the pressure doesn't build to the point of explosion.

Now, let it be said that we don't give specific advice to investors here at MarketPsych.

Nonetheless, there are some tricks that people often employ to relieve the pressure.

One of the best pressure valves we have is to sell a small percentage of certain positions to free up some cash.

This works on a financial level, but more importantly it works on an emotional level.

Why does it work?

1) It fulfills a deep-seated psychological need to do something, to take back control of our lives.

2) It creates something safe. It lets us know that at least part of the money that was at risk, is now safe. We have less exposure to pain.

3) It gives us freedom. We now have money that we can put to work on our terms. Emotional forces can no longer compel us to sell what will we have already willingly sold.

4) It's a hedge against regret. We all have the same nausea-inducing fears of regret: E.g. "The moment I sell, the market will bottom out" or "It's going to keep going down, and I'm going to hate myself for riding it to the bottom." Selling a small percentage mitigates this crippling fear.

5) It allows us to reframe crises as opportunities. We know that market panics create opportunities. The problem for so many people is they simply don't have the cash available to take advantage of those opportunities. The ability to engage other parts of our brain is another fear-fighting tool that helps put investors back on a healthy investing track.

How much is enough? 1%? 5%?... 20%? Only you can decide. Sit down with your advisor and see where you stand.

If you would like more information on our trainings, please feel free to contact us.

In the meantime... good luck out there.

Frank

The Destructive Power of Revenge: Bailout Plan Fails

Studies show that people will pay to punish others who have violated "social norms." That makes some sense, since it ensures that we all have an incentive stick to the rules. But what is more unusual is that many people will pay their own hard-earned money to punish others even if they are unaffected by the rule-breaking. They simply want revenge.

This revenge urge is even stronger in men, than women.

In fact, studies show that the neurochemical dopamine is released in the brain (reward system) of people who take revenge on others. They actually get satisfaction from punishing rule-breakers. This can be addictive, and it certainly feels pleasurable to them.

So to me it makes some sense (biologically, not economically speaking) that a majority of House memebers voted down the bailout plan. They seem willing to endure some economic pain for themselves and their constituents in order to have the pleasure of punishing "greedy Wall Street bankers" (in the parlance I've heard used by some, such as Senator Richard Shelby, on CNBC).

The problem is, the pain our economy and reputation is going to endure is likely to cost much more than $1 trillion (how many trillions in stock and bond market equity have already been lost?).

Trust and confidence in financial institutions is the grease that keeps the capitalist engine moving. Unfortunately many in Congress are saying, "we don't see anything wrong." Well, sadly, they will. The engines of credit have largely dried up, and the longer they remain dry, the longer it will take our economy to right itself again.

Banks have lost trust in each other, investors are losing trust in the markets to provide a comfortable long term return, and now we are all losing faith in the ability of government to solve major problems (some people never had that trust in government, and unfortunately they'll see that government is necessary to the smooth functioning of the economy if we don't get a bailout package soon).

I moonlighted in prisons as a psychiatrist several years ago, and I'll never forget the inmates I met who seemed "hard-wired" to be enforcers of rules. These guys would punish someone for a perceived infraction, such as disrespect (even non-verbal disrespect such as standing in the wrong place), with violence -- violence that usually landed them in "the hole" and added about 90 days to their sentence. Some of them couldn't seem to stop punishing other inmates for breaking prison "norms," and so I would see them for a psychiatric evaluation. Some told me, with self-confident righteousness, about the "high" they got from punishing rule-breakers.

This is the dark side of "righteousness"-type thinking, which often fuels revenge. And I fear some of it may have leaked out from behind bars and into Congress. I hope not, but I'm beginning to wonder.

That's my 2 cents.
Richard

Managing Fear: A Primer for Investors

How do we manage our fear in these chaotic markets?

Below I'm reposting some questions from Asa Fitch, a reporter at www.thenational.ae in Abu Dhabi, followed by my responses.

The first assumption that is good to challenge is: "Is it good to buy on fear, or should we actually be selling on fear?"

>>> What's the prevailing thinking on this?

The truth is that most of the time it is a good decision to buy on fear. But sometimes, such as in the past year, it was bad to buy on fear (especially in financials, since they have dropped 90% since the overall fear level began to increase last year). Buying on fear in Japan for the past 18 years has also been bad.

This is why Warren Buffett has said: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful" And as Buffett knows, there is more to it than just the emotion.

In the short-term, it is almost always good to buy on fear. And if you are thinking of selling because you are afraid, wait several days before acting (the price will usually be better then).

As a trader, it is best to buy on decreasing fear. And if you know in advance what events are likely to decrease fear (such as the passage of the U.S. bailout), then it is good to buy on fear there.

So before learning to "stop" fear, we have to be sure that our fear is not justified. Sometimes we should be afraid! (E.g., the financial crisis last August was only the beginning).

>>> Are there psychological strategies investors can use to get past the overwhelming urge to move to cash?

Yes, there are several techniques they can use to manage fear:
1. Externalization -- see the fear around you so that you can distance yourself from your own fear. For example, look at how much fear others are experiencing by looking at the VIX (volatility index) or the MarketPsych Fear Index (www.marketpsych.com). Then recall the Warren Buffett quote above (in 2007 he was the world's richest person, so he clearly knows what he is talking about). This quote "reframes" fear.
2. Reframing -- remember that fear is a buying opportunity. Turn from a "fear frame" to a "opportunity frame." The traditional Chinese character for crisis is comprised of two traditional Chinese characters. The second (bottom) one is "opportunity," and the first (upper) is "danger." [Corrected by Kay McCharles - Thanks!]
3. Fear is an anticipatory emotion -- it is about the future, while panic is in the moment (right now). Someone might be afraid of jumping off a pier into the ocean, but they are still safe. When they are in the water, if they are sinking, then they aren't afraid anymore - they are panicking. So changing perspective to a long-term view can be very helpful. For example, deliberately think of how happy you are in your life/family/overall finances before panicking about one small position in the markets.
4. Fear biologically induces a short-term, minute-by-minute focus of attention. We need to break that and remember the big picture. Think of long term goals, remember the justification for your current trading strategy.
5. If you haven't backtested your investment or trading system over many historical periods and examples, then you should be afraid and should not continue to use it unless you test it during a period similar to the current one -- past crises.
6. Of course, most people are long-term investors, and for them the best antidote to fear is diversification across countries, currencies, and industries. You won't get rich quickly being diversified, but you will better manage risk and volatility.
7. Comparisons -- if you are a long term investor having trouble holding tight, look at how you are performing relative to the worst sectors and funds in the market. It could always be worse.
8. Relaxation techniques -- You can use deep breathing and meditation techniques to learn to let go of the stress inducing emotions.
9. Exercise -- this is perhaps the most important technique for reducing stress and clearing your mind. Be sure to elevate your heart rate and sweat for at least 20 minutes continuously. You are demonstrating to your body (and your mind) that you can control and work through physiological "stress" -- in this case "good stress" induced by exercise.
10. Diet -- eat more whole grains, fresh and steamed vegetables, and cut out refined sugars, fried foods, and creamy desserts. Also consider an Omega-3 supplement (best is filtered fish oil) to take every day.
11. Do one thing you enjoy every day.
12. Dramatically decrease your information consumption. Most people find that they are reading several newspapers and watching many newsfeeds and technical indicators during the market day. Cut down your information consumption to the most essential 3 sources or indicators. This will help clear your mind and reduce confusion.

>>>>> Should you put your foot back in the water slowly to avoid the inherent reluctance to get back in after a big loss?

Yes, but be careful not to invest in the same areas. Many people repeatedly get in and out of the same stocks as they go down. If you sold out of your positions, and want to get back into stocks, then be sure to buy something completely different. let go of the money you lost. If you "play revenge" with the market by trying to prove that you were initially correct, you will continue to lose money.

>>>>>> Should you keep some small portion of your portfolio in cash to satisfy this urge to get out?

Yes, everyone should have some cash in different currencies for investing during crises such as the current one. The cash takes some pressure off and allows us to realize that there are many opportunities in this market. Having cash and not borrowing on margin for investments keeps us from losing everything during times like
this.

I hope that helps!

Richard