Sunday 17 January 2016

Confidence Can Only Be Built From Within

When the stock market drops, do you search the internet to find out what is happening? I do occasionally. It is OK if you just need to find out the reasons, but if you are searching for reassurances that it will not drop further, then it can be quite futile. When you read a negative opinion, you will be worried about your investments and search for more opinions, hoping to find one that will refute the previous opinion. However, even if you find one such opinion, you will still not feel assured and continue to search for more confirmation. The end result is you will end up very tired from all those searching and still feel just as unassured as when you started. Even if all the opinions you found are reassuring, the moment the stock market drops further, all your new-found confidence will be shattered. Confidence cannot be acquired from outside, it can only be built from within.

The reason why you will still feel unassured after reading all available opinions on the internet is because these opinions do not belong to you. You might agree with the opinions, but without going through the thought process of deriving these opinions, the confidence you have with them is only as strong as the next stock market movement. The correctness of these opinions is judged by the outcome (i.e. stock market movement) rather than the strength of the facts and arguments. On the other hand, if the opinion were derived by you based on available facts, the correctness of this opinion is judged not only by the outcome, but by the strength of the facts and arguments. Even when the outcome is unfavourable, you can re-run the thought process again, taking in new facts that you had omitted or just emerged, and re-evaluate that opinion. You will have much more confidence in the opinion that you derived.

There is another important thing you need to know about the stock market. It is often said that the stock market reflects all available information. We should assess what kind of information does the stock market really reflect. Consider stock recommendations from stock brokers. Even though everyone has access to the same facts, different stock analysts will come up with different price targets. Based on their own price targets relative to the current stock market price, they will then recommend to buy, hold or sell the stock in question. When investors follow up on these recommendations to buy or sell in the stock market, they are transferring the opinions of their stock analysts into the stock market. Even for investors who do not rely on stock recommendations from analysts, there is an analyst within all of us who will perform the same activities. Thus, the stock market actions that we see are really reflections of different opinions from thousands of stock market participants rather than indisputable facts which nobody would disagree.

If the stock market were to reflect indisputable facts, I would say that the stock market is always right. But if the stock market merely reflects opinions, and we know that opinions can be right or wrong not matter how strongly expressed, it means that the stock market is not always right! History has shown that the stock market can deviate from economic fundamentals from time to time, which is why we have stories such as Mr Market and timeless wisdom from investment legends to ignore the stock market. In essence, the stock market is again some other people's opinions expressed in the form of price quotations. Do you still want to treat the stock market as the indisputable truth and be extremely concerned over what level the stock market closes everyday?

If the stock market were to reflect the opinions of all investors, it might still serve as a good reference. However, it is not. You probably know of people who think the stock market is undervalued but have no money to buy further. Their opinions are not reflected in the stock market. In fact, the stock market only reflects the opinions of a very small minority of investors. Take for example, Singtel, which had the highest transaction value on Friday. A total of 31.0M shares changed hands. This was the result of 6,263 trades conducted. Assuming 2 investors per trade (i.e. a buyer and a seller), the closing price of Singtel at $3.56 reflects the aggregate opinions of 12,526 investors (plus an undisclosed number of investors who placed orders in the queue but were not successful and another undisclosed number of investors were watching on the sidelines). Contrast this with the 298,709 shareholders of Singtel (again, plus an undisclosed number of interested investors who are not shareholders) and you will see that the stock market really only reflects the opinions of a very small minority of interested investors. You might want to read The Stock Market is a Voting Machine for more information.

So really, to find the assurance that you need, you need to ignore other people's opinions, especially that of the stock market. That is not to say that you should not read other people's opinions, but it should be to identify the facts that they use to derive their opinions and analyse those facts and form your own conclusion. You might still agree with those opinions eventually, but because you have gone through your own independent and rigorous analysis, the confidence you have with that opinion is much stronger and not affected by what the stock market does next.

Not only do you need to form your own opinions about the stock market, you need to form your own opinions about individual stocks that you hold as well as your overall asset allocation and adjust them according to your opinions. Only then can you achieve the assurance that you need face whatever the stock market throws at you.

Finally, if you truly understand the essence of what I am trying to explain in this post, then you will also realise that you should ignore all that I say in this blog, because these are solely my opinions! You will have to come up with your own opinions and conclusions.

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  1. Hi BI,

    It's a fantastic read! So many people rely on other people's opinion that they lack the conviction to hold because they do not form the opinion on their own! Especially in a falling market, I believe what you say hits the spot! At least there's nobody else to blame other than yourself and you learn a lot more in the process. I think it'll be surprising to see how many stock brokers are not investors themselves, so how can one really trust them?

    Plonking in a few numbers in an auto-generated excel sheet doesn't make them more correct just because there's a lot of quantitative involved.

    Also as I was reading, this quote by Warren Buffett kept ringing in my head!

    "You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right—and that's the only thing that makes you right. And if your facts and reasoning are right, you don't have to worry about anybody else."

    1. Hi Aloypro,

      Thks for your compliments. Yes, we shouldn't be affected by what others and the market thinks.