Warren Buffett often says that the stock market is here to serve you, and not instruct you.
That’s great advice.
Yet, it’s rare to find an investor who will confess to being led by the nose in the stock market. No one wants to admit that they can be swayed by the day-to-day movements of share prices.
Instead, you’re more likely to find investors who believe the market is serving them, and not instructing them.
A dose of humility is in order.
The stock market’s siren song comes in many forms, and if it is misread, it can lead you down the wrong path.
Are you being instructed by falling share prices?
When a prominent stock falls by 20 per cent or more in a single day, it becomes the centre of attention.
Major declines often occur on the heels of unfavourable news or business results which fall short of expectations.
For many investors, the panicked response signals an opportunity.
And why not?
If share prices are lower, then you are being a good investor by buying more shares, right? It smells like an opportunity that is too good to pass up.
While there is a kernel of truth here, it is not the whole picture.
Firstly, you should recognise that it is the stock market which is telling you about these cheaper stock prices.
It’s a form of instruction, to use Buffett’s parlance, to redirect your attention to these fallen stocks which you may not have otherwise considered.
Therein lies the wrinkle: it’s not about the opportunity, but whether these are the right stocks for you.
The key question to ask yourself is: do these fallen stocks deserve a place in your portfolio in the first place? If not, you are better off leaving them alone.
Secondly, seasoned investors expect the stock market to occasionally misprice stocks, thereby creating investment opportunities.
But sometimes, the market’s assessment of the business behind the stock turns out to be right.
There are times when a business falters and its stock price is rightly reduced to reflect its declining fortunes. And if the business continues to struggle, you may find yourself buying into the wrong stock.
Thirdly, even if a stock’s price drop is a clear opportunity, it still may not work out.
For instance, if you have not studied the underlying business before, you will lack the resolve to hold on if the stock price continues to decline.
In fact, you may end up selling prematurely, thereby missing out on future gains.
Finally, when your attention is drawn to these fallen stocks, you may overlook better-performing businesses which are quietly putting up solid results to justify their rising stock prices.
In effect, when you are distracted by dramatic drops in share prices, you may be passing up on better opportunities elsewhere.
The stock market’s daily cheers and boos
Stock market moves can also act as a form of feedback to investors.
Unfortunately, in the short run, major stock price moves can send the wrong feedback to us.
In particular, if a stock you own shoots up by 20 per cent or more in a single day, it feels validating, a just reward for the hard work you put in studying the business behind the stock.
Such a sensation may cause you to overlook frailties in the business because you have made a tidy gain.
On the other hand, if your stock plunges by the same amount, it feels like harsh criticism that you have been careless in your work.
How could you have not seen this “obvious” decline coming?
Nothing could be further from the truth.
Joel Greenblatt, Gotham Capital’s Co-Chief Investment Officer, said it best: unless you buy a stock at the exact bottom (which is next to impossible), you will be down at some point after you make every investment.
Greenblatt makes a good point.
If you look at the six largest US companies today, namely Alphabet (NASDAQ: GOOGL), Apple (NASDAQ: AAPL), Amazon (NASDAQ: AMZN), Meta Platforms (NASDAQ: META), Microsoft (NASDAQ: MSFT) and NVIDIA Corporation (NASDAQ: NVDA), all of them have seen their stock prices get cut by 20 per cent or more from their highs over the past decade.
Not just once, but multiple times.
Yet, despite these declines, the sextet are worth over a trillion dollars each today.
Greenblatt adds another point: Your success depends on how dispassionate you are towards short-term stock price fluctuations. Behaviour matters.
So, yes, the stock market will test your patience by sending your shares down from time to time.
But if the underlying business is strong and continues to improve over time, your odds of getting a favourable investment outcome will increase alongside the business.
The insiders are selling, but should you?
Another popular signal is when insiders, typically the management team, start to sell shares of their own company.
Such moves are often painted as a telltale sign to sell your shares too.
After all, the insiders know more about the business than you do, and they are the ones selling. That must mean something, right?
Having the right context here is important.
Take Meta CEO Mark Zuckerberg.
According to Bloomberg, in the first two months of this year, he sold US$850 million worth of shares. At first glance, the size of his stock sale may cause you to raise an eyebrow.
But more information is needed to get the full picture.
Here’s a useful comparison: at the end of February this year, Zuckerberg had more than 347 million shares worth almost US$183 billion, based on Friday’s closing share price. So, while the amount sold is sizable in absolute terms, the sale represented less than half a per cent of what he currently owns.
Furthermore, Zuckerberg has been receiving a token salary of US$1 per year since 2013 and has not been awarded any additional share compensation since its initial public offering (IPO).
To top it off, he primarily sells to fund philanthropic initiatives and has pledged to give away 99 per cent of his stake in Meta to charitable causes over time.
In short, not all insider sales are insidious.
Get Smart: Humility is your North Star
There’s no way around it.
When you buy shares in the stock market, you have to accept that there will be times when you are unwittingly fooled by the stock market.
Having the right mindset is key.
Hedge fund manager Seth Klarman’s offers a valuable perspective. He said: When you buy anything (in the stock market), it’s an arrogant act.
You’re saying that markets are gyrating and somebody want to sell this to me and I know more than everyone else so I’m going to stand here and buy it.
That’s arrogant, he said.
Klarman adds a key point: You need the humility to say “I might be wrong”.
Ultimately, it’s this blend of confidence and humility that forms the cornerstone of successful investing in a turbulent stock market.
It’s not just about making buy or sell decisions; it’s about embracing a learning mindset that grows with every ebb and flow of the market’s tides.
Humility, in this case, isn’t merely a virtue; it’s an investor’s most trusted advisor.
Note: An earlier version of this article appeared in The Business Times.
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Disclosure: Chin Hui Leong owns shares of Alphabet, Amazon, Apple, Meta Platforms, and Microsoft.
