Before they know it, they’re trading on optimism, pessimism, greed, fear, and anything else Mr. Market throws at them. Stocks become pieces of paper, rather than portions of a business.
A great analogy describing this mistake is from Seth Klarman’s Margin of Safety. I started reading the book this week and thought it was a fitting reminder amid the abundance of good market news of late:
There is an old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”
Like sardine traders, many financial market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification; why get rich slowly if you can get rich quickly? Moreover, speculation involves going along with the crowd, not against it. There is comfort in consensus; those in the majority gain confidence from their very number.
Today many financial-market participants, knowingly or unknowingly, have become speculators. They may not even realize that they are playing a “greater-fool game,” buying overvalued securities and expecting — hoping — to find someone, a greater fool, to buy from them at a still higher price.
There is great allure to treating stocks as pieces of paper that you trade. Viewing stocks this way requires neither rigorous analysis nor knowledge of the underlying businesses. Moreover, trading in and of itself can be exciting and, as long as the market is rising, lucrative. But essentially it is speculating, not investing. You may find a buyer at a higher price — a greater fool — or you may not, in which case you yourself are the greater fool.
Margin of Safety
- Most of What You’re Going to Read Today is Pointless – S. Parrish
- Overconfidence and Inattention as Asset Return Factors – SR SV
- A New Mental Model for Investing – MicroCapClub
- Things that Go Bump in the Night – Epsilon Theory
- It’s Hard to Predict How You’ll Respond to Risk – M. Housel
- Economic Progress Doesn’t Equate to Market Returns – Morningstar
- Consumer Confidence is Lifting the Economy. But for How Much Longer? – R. Shiller
- A Conversation with Jack Bogle – Advisor Perspective
- The Mind Meld of Bill Gates and Steven Pinker – NY Times
- Amazon Health – Stratechery
- Inside Amazon’s Artificial Intelligence Flywheel – Wired