Poet, philosopher and pugilist Mike Tyson once opined, "Everyone has a plan 'till they get punched in the mouth."
After a steep decline of over 8% of the Dow Jones Industrial Average from January 29 to February 5, many investors feel like they've been punched in the mouth. The temptation is to be overcome by fear. Losing money, even if it's just on paper, can be painful. So what is the common, Main Street investor supposed to do?
First, let's talk about human nature, specifically how we handle stressful situations. After several years of a stock market that has gone up, we forget that the stock market is an adversarial place. Each party who buys a stock thinks it's a good idea. But the other party selling it to them also thinks it's great idea to do the opposite. Each have their reasons, and only time will tell who is correct. In this competitive environment, we can be wrong and we can lose. When you're money, your future and your retirement is on the line emotion can take over.
In the military, they train for this. The OODA loop is a standard operating procedure to help soldiers who enter dangerous situations. It stands for Observe, Orient, Decide and Act. The late Col. John Boyd found that pilots who could cycle through the OODA loop the fastest were the ones who got to come home to their families. Why? Because having a plan with successive steps takes emotion out of the equation. Instead of being emotionally overwhelmed or overconfident, the pilot is taking a mechanical, repeatable series of steps.
How does this apply to investors like yourself? First, if we can have an overall financial plan we can put 8% drops in the stock market into perspective. An overall financial plan, that accounts for and models various outcomes let’s us know that we've already stress-tested our investments. Second, we can apply an OODA loop to our investments. Here at Privada Wealth Management, we utilize technical indicators that follow various factors in the market. The rules we apply to our investments tell us when to tilt more aggressive and when to tilt more conservative. We Observe and Orient based on our indicators and we Decide and Act based on the rules we set up beforehand. This helps minimize emotional decision making for your long term retirement investments.
Second, let's talk about the human brain. We are constantly under bombardment by financial facts and figures. The news cycle is set up to grab our attention, primarily with negative news. If it's not the stock market crashing, it's crime on the streets. If it's not crime here, it's war overseas. Making investment decisions based on information and headlines is difficult at best. For example, if a large company loses it's founder and CEO to cancer, common sense would say we might want to sell the stock. Think about the vision and execution that a CEO brings to the company. On October 5, 2011 Steve Jobs died. As of February 5, 2018, Apple stock is up over 180%. So much for common sense.
The cure for the human brain is using computers to crunch the numbers and follow the rules. The fancy word for rules is algorithms. No need to wake up and walk outside in your bathrobe to pick up the daily financial newspaper. All the data points and opinions of the financial pundits are already baked into the current market price. Remember, when the market goes up it's because more people think buying is a good idea and the sellers require a higher price. The reason for their opinions are as varied as the investors themselves. We need to what the price trend is, not why it is. Also, when the market goes up or down we like to use hindsight to give the reason why. Hindsight is great for stock market historians, but investing requires something more.
Make no mistake, rules-based algorithms based on technical indicators are not a cure-all for investment fear and greed. It doesn't always outperform a static buy and hold approach. But it is another tool that we can use to help you stay on track when the market punches you in the face. If you'd like to learn more how this can apply to you click here.