#How To Use Emotions In Stock Market To Your Advantage
Emotions in stock market are often considered bad for your investment decisions.
What if I say that emotions like Fear and Greed are not bad when it comes to investments in stock market. After all they are perfectly normal emotions that arise in all living beings alike.
But Why do I say that emotions are not bad in stock market? Well. This question will be answered in a short while through an example of an investment I had made in 2013.
In past 6 and a half years of full time equity investing, I have experienced emotions like fear, panic, anxiety, greed, anger and even attachment to stocks multiple times. Even my temptation to sell a stock and instantly gratify myself has been tested many times over.
Folks. Even the best of Chartered Accountants, MBAs and others with degrees in finance and economics find it difficult to make money in stock market.
The main reason for this is a lack of wisdom to accept and use our emotions to our advantage.
Therefore in this post I am going to share an investment story. A story which will show you some of the emotions an investor has to go through.
We will also see how an investor can leverage his/her emotions in stock market for being a successful investor. So stay tuned.
A Desire To Make Money
I started my investment journey in the year 2012. What was the motivation behind my investments?
A desire to make more money and this desire itself seems to stem from an emotion of Greed.
In order to be in control of your emotions in stock market you need to first accept these emotions. That is why I have acknowledged my strong desire to make more money which is inspired by the emotion of greed in one way or the other.
In order to satisfy my desire, I worked hard to search for my next multibagger stock. Finally in October 2012 while trying to find my next multibagger, I stumbled upon a company named La Opala.
La Opala RG is an Indian based tableware company whose products are made of Opalware glass.
Back then all I looked for in a company were rising sales and profit numbers, along with little debt and rising operating profit margins.
Therefore a look at the rising sales, profit and operating margins convinced me to buy this stock. Another thing that appealed to me was its declining debt to equity ratio.
So here was a company which catered to the Indian consumer segment and was growing at a fast clip.
As the stock was a good fit on all parameters I decided to buy my first 500 shares at a price of 152 Rs on 28th October, 2012.
Excitement, Greed, Fear, Anger & Temptation For Instant Gratification
Soon after my first purchase of 500 shares by the end of Dec 2012 stock flirted with 280 Rs a share. As I watched the stock go up I was overwhelmed by emotions of excitement, greed, fear and anger at the same time.
Excitement because the stock was rising too fast. Greed as I wanted to buy much more of it Fear as I did not want to lose my gains and anger because I did not buy lots of it in the beginning at a price of 152 Rs a share.
I also experienced a temptation to book profits as the stock had almost doubled.
So what do you think I would have done at this point in time? Sold my shares, did nothing or bought more shares?
Well. Folks. I had gone crazy. Greed had taken complete control of me and I decided to buy more shares of La Opala at varying prices of 258, 267, 283, 320, 342, 348 and so on.
So I kept aside the emotions of excitement, fear, anger and chose Greed at this point in time.
But was my greed unfounded. Did it arise purely due to a surge of emotion or was it backed with facts?
I had become greedy to buy more shares of La opala as the company was reporting a sharp increase in sales and profit numbers.
La Opala had reported a sales growth of 71.7% and profit growth of 151.49% for Q3FY13 over Q3FY12. This gave me the comfort to buy more.
This dear readers is an example of Greed used to the advantage of an investor.
My Learnings From This First Episode
Let us summarize my learnings from this episode:
1. When confounded with emotions in stock market like greed or fear please make use of facts to justify your actions.
Yes i chose to be Greedy and not Fearful as the facts showed that La Opala as a company was doing extremely well
2. Resist the urge to instantly gratify yourself by booking profits if the company is doing well. Your trait of patience gets tested in this scenario.
Instead of booking profits I decided not only to hold my existing shares but also bought more shares
Buy & Hold - Test Of Patience & Temptation of Instant Gratification
After the emotion of greed made me buy a lot of shares of La opala, I decided to follow Mr. Warren Buffet’s strategy of buy and hold.
Therefore I resolved to hold on to my shares as long as the company kept reporting strong financial numbers.
Please have a look at La Opala’s financial numbers from 2012 to 2016 below. Sales and profit numbers were growing rapidly. In fact the profit had more than quadrupled.
As the company kept reporting better numbers my conviction to hold only got stronger.
Even a rising stock can put your emotions to test. La Opala tested my patience to hold on to my stocks and resist the temptation to sell shares and gratify myself.
Why? Because the stock by the end of 2015 was quoting at an insane price of 3180 Rs a share.
I had resisted the urge to book profits at 250, 300, 500, 1000, 2000 and even 3000 Rs.
First Sign Of Fear
In May 2016, La Opala RG (Opal glass tableware manufacturer) a stock which I had been holding since 2013 reported a minor decline in its revenue of 12.1% while profit increased 33.6%.
I often study research reports published by various brokerages to look for important reported facts.
While reading the research report from Nirmal Bang on La Opala RG published on 17th
May 2016, there was one statement that caught my attention
Nirmal Bang in their research report stated that La Opala had reduced the prices of Diva range (constituting 70% of sales) of opal tableware by 15%.
Simultaneously, company reduced promotional trade discount provided to dealers to 0% from 15%. La opala had done this to promote volume growth.
The reason why this statement is important is that La Opala was a dominant player in opal glass tableware in India. In the 3 years that I held the stock company never reduced the prices of its tableware products.
I immediately realized something was not right. Therefore I visited a few dealers to know the reason for this price reduction.
On inquiring I found out that Borosil (another Indian glassware company) had launched its opal glass tableware under the brand name Larah recently at competitive prices.
Confusion, Fear, Attachment Versus Logic Based On Facts
Over the next few days I had to decide whether to sell my shares or hold them. On one hand was my attachment to this multibagger stock which made me experience what
b) This price reduction would eventually lead to a decline or stagnation in La Opala’s growing sales and profit
I was utterly confused as I had come a long way holding it from 150 to 2800 Rs. After all my decision could have gone wrong and the stock could have gone up as well.
Finally I decided to go with the facts and sold all my shares on 22nd May 2016 at price of 2590 Rs a share.
As an investor you can only look at facts and take a call based on facts in hand.
For me the stock was trading at an expensive valuation of a PE > 50 and the entry of Borosil in opalware market meant slowing growth of La Opala.
Once a company stops growing at a faster rate market will automatically lower its valuations
Did I Take The Right Decision?
My decision to exit La Opala was actually right as recently the stock hit a low of 1400 Rs and currently trades at a PE of 24.
Once Borosil entered opal glass tableware market, sales of La Opala have not been able to show any meaningful growth and the stock corrected to a more reasonable PE ratio.
Please see the stock chart below justifying my decision to sell La Opala in 2016. Please note that stock has been split. Therefore a price of 140 is equivalent to 1400 Rs.
Few lessons that I learnt from my sell decision were:
1. Once things change an investor must change his mind. As in my case once I learnt about the entry of competition I decided to change my buy and hold strategy
2. Keep aside all emotions of fear, greed, ego or attachment and focus only on facts.
3. Once you act on your decision verify whether you were right in your assessment or not?
If not then there is no point in brooding over the past. Instead you need to learn a lesson and move on.
Yes all this is easier said than done but I have tried to do it and so can you.
When To Be Fearful When To Be Greedy
Emotions in stock market can provoke us in to taking wrong decisions. Therefore before you decide to buy or sell based on emotions it is advisable to think rationally about the problem.
I am providing below some common scenarios that an investor may face during his investing journey, the emotions to be avoided and a possible rational solution
By being aware of these scenarios or the reason for a decline in stock price you can take a rational decision despite being overwhelmed with emotions in stock market
After all, Emotions in stock market are not as bad as people think. For example, fear keeps us on our toes.
It helps us prepare for a negative outcome. It is when you act impulsively without weighing the facts that it begins to hurt.
Therefore before we end this post I would like to re-emphasize the following:
1. Please use emotions to your advantage. For this you need to first accept the emotion you are undergoing
2. Before you act impulsively under the influence of emotions in stock market, search for facts, assess the situation and then act logically
I hope you will find this article useful. If you have an interesting scenario where your life or stock markets tested your emotions then please feel free to share your experience and learning.
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