If you want to learn why the stock market goes through periods of extreme volatility, reruns of Pawn Stars shows you exactly why, several times each weeknight. Here’s how it works: some guy walks in the shop with a random item. His wife has been bugging him to get rid of it or his rent is due or his dog needs an operation, etc. He offers to sell it for an outlandish sum. One of the pawn shop guys counters with a hilariously low price. They settle on something close to the hilariously low price. Everybody seems to be happy with the outcome.
Storage Wars shows the other side of the coin. The unknown contents of abandoned storage units are auctioned off to a group of frenzied bidders that hope to flip the contents for a profit. They compete and sometimes drive the price to absurdly high levels. The “winning” bidders celebrate with high fives and fist pumps.
The common motivator in both scenarios is the desire for immediacy. It’s a classic illustration of supply and demand. When your supply of cash is low and your demand is high, the value of cash skyrockets compared to the value of a non-cash item. That you could have gotten a higher price for the item somewhere else is irrelevant unless that other buyer is standing right in front of you. Immediate cash and delayed cash are completely different things to this person.
The immediate buyer is basically the same. His personal supply/demand equation places a low value on cash relative to whatever he’s trying to exchange it for. The problem both parties share is that their need for immediacy puts them at a negotiating disadvantage.
Periods of great upheaval in stock prices are the result of a large imbalance in negotiating power. A person ruled by the need for immediacy places more value on the completion of a transaction than the price. The disadvantage suffered by that person compounds quickly when a flood of like-minded people join in. When demand for cash spreads among owners of a stock, a buyer doesn’t have to guess your lowest acceptable price. He can try to guess the lowest acceptable price for the group and then let everyone compete. This is why prices quickly crash or spike – sellers or buyers are racing to meet the demands of those with the upper hand.
So how do you avoid investment mistakes that result from being ruled by immediacy? Better yet, how do you become one of those investors with the upper hand?
- Avoid over-concentration in a single position or market. When a single investment can imperil your financial survival, you are ruled by conditions outside of your control.
- Avoid becoming over-leveraged. Debt service is no joke. A margin call or looming interest payment can force you into the worst possible timetable.
- Pre-plan EVERY decision. You don’t have to know the future to know how you will react to it. Rules that govern buying and selling decisions help you maintain discipline and avoid impulsive behavior.
- Be OK with doing nothing. Sometimes the hardest part of being disciplined is waiting, but one of the biggest advantages of having the upper hand is the luxury of saying no. The pawn shop guys are always willing to walk away from a deal because they know there are a hundred others lined up behind that one. Investors have that option too.
A huge part, probably the biggest part, of being a successful investor is rooted in psychology. Making good decisions consistently depends a lot more on our thought processes than on the latest economic or market news.
Disclaimer: Past performance is not indicative of future returns. Information displayed is taken from sources believed to be reliable but cannot be guaranteed. All indices are unmanaged and investors cannot invest directly into an index. Ideas and opinions expressed in this article are the sole responsibility of Patrick Crook/PLC Asset Management and do not reflect any stated opinions of LLP Financial LLC or any other person or entity.