How To Cope With Market Cycles

What is the key in all of this?

• To know where the pendulum of psychology and the cycle in valuation stand in their swings.
• To refuse to buy when too positive psychology and the willingness to assign too high valuations causes prices to soar to peak levels.
• To buy when downcast psychology and the desertion of valuation standards cause panicky investors to create bargains by selling despite the low prices that result.

The investor’s goal is to position capital so as to benefit from future development. The first step is to decide how you will deal with the future. To respond to market cycles, and to understand their message one realization is more important than all others. The risk in investing doesn’t come primarily from the economy, the companies, the securities, the stock certificates, or the exchange buildings; it comes from the behavior of the market participants. So do most of the opportunities for exceptional returns. The key to behaving in a way that is appropriate given the market climate lies significantly in accessing the psychology and behavior of others. If valuations aren’t out of line with history, the market cycle is unlikely to be highly extended in either direction.

Two key questions in assessing the market:

1.How are things priced?
2.How are investors around us behaving?

The answers will give us a sense for where we stand in the market cycle, but they will not tell us what will happen next, just the tendencies. In an extreme bubble, all the rational investor has to do is be able to identify nutty behavior when you see it. Try to behave as an observer viewing with detachment from the sidelines. Waiting for the market bottom is folly. You should buy when the price is below intrinsic value. If the price goes lower, buy more. Exiting the market after a decline, and thus failing to participate in a cyclical rebound, is truly the cardinal sin in investing. When the market is high in its cycle, investors should emphasize limiting the potential for losing money. When the market is low in its cycle, they should emphasize reducing the risk of missing opportunity.

How?

Try to travel into the future and look back. Five years from now, do you think you are more likely to say “Five years earlier, I wish I had been more aggressive” or “I wish I had been more defensive.”

Cycles will happen to you, what you do in response is the key.