Introduction
Learning how to buy stocks based on value investing principles is relatively straightforward. The only requirements for a successful value investor are the ability to assess a company’s value and the right psychological approach to stock prices, which involves recognizing hope (enthusiasm or greed) and fear.
Enthusiasm and Fear in the Market Metaphor
In his classic book “The Intelligent Investor,” Graham captured the ups and downs of the stock market in a single, irrational business partner. Imagine you own a small stake in a private company that cost you $1,000. One of your partners, named Mr. Market, is very accommodating. Every day, he tells you the value of your interest and suggests either buying your share or selling an additional share based on that. Sometimes, the idea of value seems reasonable and justified by the business developments and prospects you know. Often, Mr. Market allows his enthusiasm or fear to take over, and the value he proposes to you seems a bit irrational.
The Freedom of Choice
The best part of this entire metaphorical arrangement is: 1) you are free to ignore Mr. Market if you don’t like his price and 2) he will always provide you with a new price the next trading day. As long as you have a strong conviction about the company’s true value, you will be able to intelligently accept or reject Mr. Market’s offers. The choice is always yours. At the same time, you must understand that the company’s intrinsic value may not have changed significantly – only Mr. Market’s mood.
Emotional Detachment
By thinking of stock prices as offers from an emotionally unstable business partner, you can free yourself from the emotional attachment that most investors feel toward the ups and downs of stock prices – and from the illogical emotional decisions that this emotional attachment can lead to.
Soon, when you look to buy a stock, you will welcome price declines without any emotions. And you will cheerfully welcome stock price increases when you look to sell your current securities.
Sources:
– Victor Cheng. “The Psychology of the Absurd Valuation.”
– Benjamin Graham. “The Intelligent Investor,” p. 32. Harper Business, 2005.
– Catana Capital. “Sentiment Analysis – What Is Market Sentiment and How Does It Affect the Stock Market?”
– Toptal. “Why Investors Are Irrational, According to Behavioral Finance.”
Source: https://www.thebalancemoney.com/basics-of-value-investing-358141
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