7-point plan for staying patient: Beware the deadly combination of big bets and market noise

In the previous post, we talked about keeping some powder dry. That’s all well and good I hear you say, but it says nothing about answering the question … when should I act? The answer has a lot to do with understanding the significance of a market opportunity with respect to your investment timeframe. Or to put it another way, short term trends can look like mere blips in a longer timeframe. The patient investor understands the dangers in responding en masse to sharp, but strategically insignificant, market movements.

The book ‘Reminiscences of a Stock Operator’ was written in 1923 as a fictionalised account of the life of securities trader Jesse Livermore, a market speculator who made and lost his fortune many times over, offering sage advice to young traders based on his experience. Over time it has become revered as something akin to a trader’s bible, and an all-time ‘investment classic’.

One of the key themes to be drawn relates to the dangers of over-trading, i.e. responding to each and every market movement. Or as we might call it, ‘getting sucked into market noise’.

When markets get volatile, it becomes increasingly difficult to distinguish real opportunities from alluring temptations. In fact, in a lower return and higher volatility environment, the common trait of the impatient investor is to jump in and do something. After all, sitting around being diversified and staying close to strategic allocations just isn’t as sexy as trying your luck to capture some of the huge short term swings in asset markets, right?

Assuming you have followed the previous steps in the 7-point plan, and have therefore built a robust, diversified and disciplined foundation for your overall investment plan, volatile markets require the patient investor to employ their ‘dry powder’ to capture value toward the extremes, staying out of the noise in the middle. In a data-driven market where good news is good news one moment, and treated as bad the next, making large strategic shifts can often become a trap for the unwary.

You MUST understand the significance of an opportunity with respect to timeframes and underlying fundamentals (i.e. the lay of the board). If you fundamentally believe a near term market move creates an opportunity (e.g. large upward moves against a backdrop of deteriorating fundamentals, or vice versa), check how significant the movement looks across multiple timeframes (short, medium, long term). The longer the timeframe impacted, the potentially more significant the opportunity, and larger the allocation shift to capture it. Conversely, the shorter the timeframe impacted, the more tactical the opportunity and hence the smaller any allocation shift should be.

In a low return and high volatility world, the starting point is to stay close to your strategic asset allocation and have clear boundaries regarding any tactical range around it. This is a necessary discipline to keep you from yourself. Then employ any ‘dry powder’ (e.g. earmarked cash) according to the size of the opportunity and the timeframe impacted. Save most of your powder for the larger opportunities. This will keep you out of the noise and provide you with a higher likelihood of capturing significant medium to long term value over time. But remember, at times this approach can be an excruciating test of your patience. So stay disciplined!

So much for asset allocation decisions, in our final post we’ll have a brief look at the importance of security selection INSIDE asset classes, a critical additional final bow to the armoury of the patient investor in a low return environment.

This article forms part of the 7-point plan for staying patient series.