Quote for the Week

How does one identify risk tolerance? Our thinking on this was that the issue is not so much tolerance for risk as it is tolerance for losses. Tolerance for losses means that you have to know — the individual investor has to know and certainly the advisor has to try to know — how much loss the person will be able to tolerate before he changes his mind about what he is doing. Clearly, changing course by and large is not a good idea, and selling low and buying high is not a good idea… If people are very prone to regret, then you have to help them devise a plan that will minimize their regret. For the very wealthy, emotion is clearly important in determining what policy is appropriate…

The main question that I have found useful to ask when someone is very wealthy is how much loss is the individual willing to tolerate? That is, what fraction of their wealth are they actually willing to lose? It turns out that fraction is usually not very large. That’s a very important parameter… Then you have to take steps so that they won’t lose more than they are willing to lose. That’s in effect stop-loss policy…

Also, people have to become aware of the fact that by stopping their losses, they are giving up some potential upside. Looking at the trade-off between the upside and the downside gives you a sense of their attitude toward losses and what you should encourage them to do. — Daniel Kahneman (source)

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Quote for the Week

In the last analysis, it was the public which was chiefly responsible for its own undoing. The stock-market boom was a classic example of the madness of crowds. History records some of the most notorious of these mass movements — the Mississippi Bubble, the South Sea Bubble, the Tulip Mania — and the madness of the ’20’s must certainly be added to the list. The prehistoric tribal eruptions from Central Asia, the Crusades, the medieval dance craze, all these — right down to the Florida boom and the 1929 market madness — were phenomena of mass action under impulses which no science has explored. Such impulses have power to affect any static condition or so-called normal trend. For that reason they deserve consideration by students of economic affairs.

Although there is no scientific cure for these madnesses, there may be potent incantations. I have always thought that much of the evil might have been averted if, in the lamentable era of the New Economics culminating in 1929, even in the very presence of dizzily rising prices, we had all continuously repeated that “two and two still make four.” And I think it would be a salutary thing in the present situation, which in many respects so resembles the ’20’s, if we reminded ourselves of the fact. — Bernard Baruch (source)

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Quote for the Week

In every bank and brokerage house, in business places, on street corners and in elevators and restaurants — wherever people met — one could hear talk of ”the tip I got on the market.” Token margin requirements enabled anybody to test his luck. Taxi drivers told you what stocks to buy. The shoeshine boy could give you a summary of the day’s financial news. An old beggar, who regularly patrolled the street in front of my office, now gave me market tips — and, I suppose, spent in the market the money I gave him. My cook had a brokerage account and followed the stock ticker closely. Her paper profits were quickly blown away in the gale of 1929, and she had to be rescued from being sold out entirely.

Whenever some cool, calm voice like Sen. Carter Glass’s was raised against this madness, it was jeered. Whenever the market fell back — and there were some sharp setbacks on occasion — assurances that all was well would come from every quarter. Unfailingly the prophets of the New Economics in government and finance promoted the boom and nourished public confidence in it. From the White House itself came President Coolidge’s soothing statement about the mounting loans on stock exchange collateral, that ”five billion isn’t very much.” In those days it was…

There were some who believed that prices would never descend and others who thought that, if they did, it would still be possible to get out in time. But of those who realized that the boom had to end, none knew when the expected break would come. — Bernard Baruch (source)

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August 25, 1987, marked the start of the one of the worst slides in market history. In less than two months, the Dow dropped 983 points — 508 on those on the last day.

Black Monday, as it came to be known, was believed an impossibility. Nothing would ever come close to the one-day losses seen in 1929.

The Friday before finished the week with three straight days of market losses. It also marked the worst one-day point decline in Dow history. The 108.36-point loss equated to a 4.8% decline going into the weekend.

When the NYSE opened Monday, October 19th, international markets were already falling. The Dow was off 67 points at the opening bell.

By 10:30am, 140 million shares had traded. The Dow had fallen another 34 points.

A brief 95-point rally raised hopes around 11:30am. The rally fizzled and the Dow turned lower again by noon to 2103. By 2:15pm, it was in freefall — down 300 points with no end in sight.

At the closing bell, 604 million shares traded, almost twice that of the Friday before, and four times the normal average volume. A new record. The Dow closed 508 points lower. Also, a new record. The 22.6% decline was (still is) the worst one-day loss in history.

The headlines reported it the next day:

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