The Miracle of Thought

Our thoughts and imagination can take us to amazing places. What is thought of as impossible one day can easily be accepted the next.

It is an interesting notion that preoccupies many of us involved in the stock market. Stock price movement follows the ebbs and flows of changing investor sentiment. Their ideas, thoughts, feelings and perceptions.

Stock price movement can often be seen as at odds with the most common form of stock analysis – fundamental analysis. This is understandable because realistically they are two very different beasts driven by two entirely different influences. So, we need to understand this to make sense of both forms of analysis and their uses.

Fundamental analysis is the assessment of a company’s performance and the shape it’s in. Its profit and loss, balance sheet, return on equity and many other financial measures that we use to assess a company’s value. The fundamental analysts’ models arrive at a value and often try to forecast certain model inputs to get a future idea of value. As those model inputs change so too does the perceived value of a company. This however does not take into account sentiment, a general term relating to human behaviour which affects stock prices and is nigh on impossible to value.

Price analysis is the assessment of a company’s share price movement. It doesn’t attempt to value it but rather understand the mood swings of human behaviour. These ‘moods’ drive price trends and we can determine how strong or weak they are by assessing the buyer and seller participation levels. Human behaviour is very repetitive and easily observed and thus responds in similar ways to similar events. The primary emotions of human behaviour in the stock market being fear (of losing money) and greed (I want to make more and more).

The most interesting and exciting prospect of price movement is that which we cannot value. It is the emotional value. It is the blue sky of imagined possibilities. It can stretch prices far from perceived value and often surprises us. Under these circumstances prices inevitably move fast and hard driven by the urgencies of the fear of missing out or the worry of a losing money. Once we take a step back the scramble seems absurd and insensible, yet it happens with uncanny repetition. It’s how we think.

For those willing to take the journey of psychological empathy you will be rewarded. Take the price at face value and learn to take advantage of price movement and follow it. ‘Don’t fight the tape’ as Jesse Livermore, legendary stock market trader tells us.His success in the markets was that incredible that he amassed a $US100m fortune back in 1929, literally billions of dollars today. His main point being, don’t ignore what the markets are trying to tell you – he often called it the tape!

The price analysis style of investing might not suit everyone; however, it is price movement itself that we profit from so an analysis of price seems logical. It can be a wild ride at times just as human behaviour can be. In a previous article in the March 2019 publication of this journal I discussed the issue of control and its necessity when following trends. This is of utmost importance to preserve capital when riding these waves of opportunity. The fundamentalist is often dismayed by this price action, so it is probably not for them. It’s our imagination.

Those prepared to go with it, understand it, and accept that fact that price movement is a function of human psychology that often takes prices to stratospheric levels can learn to benefit from it. Through a knowledge of price behaviour and how and why it moves we can learn how to take advantage of it, and profit handsomely from it.

Whichever way we want to look at it, we are in this game for not only the challenge and passion, but of course to make money and not fight the realities of price movement or human nature. They are real. Price movement has little to do with the actual fundamentals but rather the perceptions. Measures such as P/E ratios can become wildly out of whack for just these reasons.

Over extended prices come back to reality and that too is human psychology. Emotions change and often quickly. It’s how we work and think, its fear and greed. Assessing that change is a challenge to be managed carefully. The whole process of price analysis and investing successfully on that basis is very much a robotic rule-based process that takes advantage of human behaviour, both up and down. This may seem a misnomer, but when grasped and understood it is a hugely rewarding pursuit. When the light bulb goes on you invariably don’t look back.

The examples of Tulip mania or more recently the Internet boom we know are oft repeated events. There can be huge waves or merely ripples of opportunity. It can be surges of themed sentiment or it can take a hold of individual stocks to varying degrees.

The reality is human psychology drives stock price trends and we often see the power of our imaginations do amazing things, regardless of reality. Learning to harness that power has been my passion of over 30 years. It may one day grab you too.