Editor’s note: This article was first published in August 2015. The word “recently” refers to the market turmoil of late August 2015, with daily falls of 5–8% followed by rebounds.
Markets fall and the public panics. Markets rise and investors become euphoric. But for thousands of traders to make money there has to be movement, whether up or down. Those movements (volatility) are what expose small investors, who start to lose sight of the long term and let themselves be carried away by the emotions that market swings produce.
In Berkshire Hathaway’s 1987 annual letter, Warren Buffett used a metaphor inherited from his teacher and mentor Benjamin Graham to explain how the market behaves and the difficult relationship between investors and markets.
See also: Warren Buffett’s 16 best pieces of investing advice
In the letter, Buffett set out the metaphor along these lines:
Dealings with Mr. Market are anything but dull and steady. Why? For the sad reason that the poor fellow has incurable emotional problems.
Sometimes he feels euphoric and can see only the favourable factors pushing businesses up. When he is in this mood, he names a very high buy-sell price, because he is afraid you will snatch his stake away and rob him of his imminent gains.
At other times he feels depressed and sees nothing ahead but trouble, both for business and for the world. On those occasions he names a very low price, because he is terrified that you will unload your stake on him…
But, as with Cinderella at the ball, you must heed one warning, or everything will turn back into pumpkins and mice. The market is there to serve you, not to guide you. What you will find useful is his checkbook, not his wisdom.
If one day he shows up in a particularly foolish mood, you are completely free to ignore him or to take advantage of him, but it would be disastrous to fall under his influence.
In fact, if you are not sure that you understand and can value your business far better than Mr. Market does, you don’t belong in this game and you don’t know the rules. So you will end up losing.
Recently we have seen stock markets fall 5% and 8%, only to open the next day up 3% and end up closing 2% down. These are moves in which speculators can make a lot of money. But if you are not a speculator, or if until now you have been a long-term investor with a portfolio of solid stocks, beware of getting carried away by the emotions of “Mr. Market”.
This is the time to think very carefully about the strategy to follow under the different possible scenarios, and probably one of the worst times to make hasty decisions based on these moves.
Further reading
- The DCA strategy for making money if you expect the market to fall
- Tips for making money in a bear market
- 5 stock market books every investor should read
Featured image: Miscellaneous Items in High Demand, PPOC, Library of Congress, Public domain, via Wikimedia Commons.
