Dealing With Emotion During Ups and Downs
The best investors all advise similarly on how to address emotion while investing — if possible, remove completely. This is the type of advice that sounds wise and feels even better to tell someone else; but in reality we humans are always dealing with emotion no matter what we’re doing, and in particular for this discussion while stock picking. Who hasn’t wanted to share with friends a stock in their portfolio that is rocketing higher (pride), or felt awful when seeing how great someone else is doing if their own stock picks are lagging (envy, shame, doubt).
Halo Effect:
In the past month I’ve felt all manner of emotions while observing the market, most especially pertaining to my most recent stock pick HALO 0.00%↑. Halozyme was up 35% YTD prior to its earnings on May 6, after which it rose another 18% the following day and was one of the market’s best performers of the year. When a stock one picks is greatly outpacing the market, it’s natural to feel smarter than you actually are. Like most emotions, this can be fleeting, and with HALO 0.00%↑ it was especially so as this week news from how medicare may handle drug negotiations in 2028 and beyond caused the stock to erase all of its year to date gains.
For stock pickers like myself, we own very few stocks but have high confidence in each of them. This strategy is the opposite of diversification, on which Warren Buffet quipped, “diversification is a protection against ignorance. It makes little sense if you know what you are doing.” So when a stock goes down unexpectedly, this brings forth feelings of shame and fear. What if I am wrong, and I actually don’t know what I’m doing? With all things, this should be considered in the subset of possibilities, but as you are engaged in the action it should not be allowed to take over. An investor must recognize which emotions he is feeling, and then work to either overcome them or put them to good use.
When the initial medicare note was released and the stock was downgraded by Morgan Stanley and Leerink Partners, I immediately read their reports. Based on the information available, it made little sense that the stock would drop 25% in a single day. When this is the case, an individual investor should start buying. The logic being that the market is offering a temporary discount on a stock one sees long-term potential in. Being that HALO 0.00%↑ is 20% of my portfolio, I hesitated to buy even more at a discounted price (now at par with my cost basis).
My reactionary anger was telling me to sell some other holdings and pile into Halozyme just to spite the market being (in my view) so wrong. This may turn out to have been correct, but it was driven from emotion and so upon reflection I decided to simply hold my current stake. Halozyme’s results and earnings call on May 6 was one of the best I read all year, so my positive long-term view of the stock remains unchanged.
Ups and downs have been common this year with all the geopolitical and economic uncertainty. For example, my largest holding META 0.00%↑ reached $737 and just two months later was at $484. The open question is how you as an investor will react or what actions stock movements will elicit from you.
"If you can't stomach 50% declines in your investment, you will get the mediocre returns you deserve."
—Charlie Munger
Practical Concerns:
Most people’s actions are driven by avoidance of worst case outcomes and embarrassment rather than the maximization of potential positive outcomes. I often worry my stock picking is erring towards risk aversion because of two personal factors. One being I am writing publicly about the investments and will feel embarrassed if I get it wrong, and two being I no longer have a stable income so am less likely to take large risks.
Consistently reminding myself of the practical concerns and emotions which pull my actions in one direction allows me to take corrective action against them. This doesn’t mean I seek reckless opportunities because my personal situation inclines me to be risk averse, but the recognition of the pull creates space to overcome it.
Dealing with emotions while investing shouldn’t mean removing them entirely, because that is infeasible for most of us mere mortals. Rather it should be recognizing which emotions we are feeling and not allowing these to be the driver of our decisions. There’s nothing wrong with sharing a successful stock pick with friends, but when one gets that feeling of overwhelming pride consider the possibility that it could be time to sell.