Exploit Other's Fear

"Buy when there's blood in the streets" - Rothchilds 

I work the Fear side of the market for GF Capital Advisors. I look for companies whose share prices are completely out of whack with reality because fear has induced a panic of selling. Why do I prefer to work fear?

Fear is 2.5 Times Stronger than Greed in Humans
How do I know this? From observing stock charts over the years. Stocks move down about 2 to 3 times faster than they go up. People will act quickly and irrationally in fear. Greed is much slower and weaker in people than fear. However people only act irrationally in fear for short bursts.

I think it makes some sort of sense from an evolutionary perspective. Fear is an emotion to prevent harm; it is in us to keep that jaguar from tearing our neck off and eating us. There is a sense of urgency in fear that takes over a person’s thought process. 

Fight or Flee becomes the response people have to fear. Well, in the stock market you can’t go beat the chart up, or kick the CEO’ ass of the company (well not legally!), so the only other option people have is to Flee. Flee means sell in the market. And flee they do when they get afraid. Stocks crash at high speeds when they start moving down. 

This is one emotion that can cause deeply inefficient markets. As the Fleeing is going on, many more people get afraid and decide to flee. Their collective fleeing becomes a stampede of fear induced fleeing. 

As well, experienced investors and all people who follow a “trading” style investment paradigm, wont touch a falling stock with a 10-foot pole either. With no one to stand in the way, a stock falls into the abyss. Essentially there is nobody to hold it “up” with buying. At some point, that is where the inefficient investor comes in.

 Although, I try to wait for a bottom, at some point, I stand in front of them. I LAUGH AND I BUY!

If you really look at what I do, I usually play “fear”. When others are afraid, I get greedy. When they get greedy, I get very afraid. 

In contrast, if you look at the predominate stock picking strategies out there, they play “greed”. Most stock picking strategies you will read about, say only buy stocks going up, and only those in the strongest sectors. Many people will say the best stocks have the craziest PE ratios. This could very well be true, because a lot of people are bidding them up, and if you buy them you can ride their wave up. But at some point, these “greed” strategies are utilizing the Greater Fool Theory of Investing. At some point, the not as greedy traders will take some profits, and enough selling will occur. From there the price will come down and the price move down will become fear very quickly.

I prefer the “fear” side. Why? Fear is much stronger. About 2.5 times stronger to put a mathematical expression on it. This means, where there is fear in a stock there is a 2.5 times stronger move, and therefore a potentially much more inefficient stock price move to profit from. However from experience it can take a several year window to exploit fear.

As well, I try to wait to find the bottom. Some times if it gets to DUH, I will go ahead and enter the market anyway.

There are two ways to play fear.

1. Short during the “fear” cycle. This requires more of a trading style then I usually do, but it is certainly worth it. The problem with this method is since fear works so fast in the market it is difficult to time and keep money invested.   

2. Or as I prefer to do, wait until the selling is ending and an investor is buying a company at a steep discount to its value. This takes a lot less trading acumen, and to me is an easier way to make money. However, the time involved between buying low at the end of the panic and selling high in the recovery can last years, but often the returns over the time period make it worth it. The trick to making money is to only buy when stocks hit what I call DUH!

The Pursuit of DUH!  

Stupid is Forever -- Anonymous  

 I am always waiting for stocks to get to “DUH”. DUH is the price where no matter what happens, you are almost assured you are going to make money. DUH, is so dumb, you marvel at how bad money is being invested in the world. DUH, is so dumb, you figure that you are the idiot and you have totally missed something and the rest of the world hasn’t.

DUH is almost the easiest money you could make. DUH doesn’t happen very often. DUH is also very scary! Because usually a company whose price is at DUH, must have something grossly wrong with it, or there is a perception in the market that there is something grossly wrong with the business sector it is in. This is where hardcore research can make the difference. Most companies this cheap have a problem and the market is being efficient. However, a small percentage are not. These are the ones that can be confidently bought.

Here are some ways to find DUH! 

How to Find DUH!   

Price/Cash approximately 1 

When you find a near profitable or preferably profitable company that is trading at its cash book value, you have just found a DUH candidate. 

Think of this.

If you walked into your neighborhood McDonalds, and offered the owner of the McDonalds the cash in his till for his McDonalds, what do you think the response would be? Laughter most probably. Have fun, try it sometime. Go up to the owner and ask “Yes, that is right, I will give you 300 bucks for your franchise. Included in my splendid and smashing offer, you will sell me 400 bucks of cash in the till, your building, inventory, and your cash flow. Do you think they would take it or laugh at you? You bet they would laugh, or worse, tell you to buy a cheeseburger and get lost. 

The amazing thing is this does occasionally happen in the stock market. Often these companies are in sectors that are getting pummeled, and the companies may be having temporary problems. Sometimes, it is even easier though. A current example may be as of early 2000 Internet Consulting companies are being priced like this. Many of them can be turned profitable just by letting a few people go. Many of them have let people go. The Internet is not going away. DUH. I think we just found it.

At this point, there is almost no way to lose money on the investment. Someday, somebody somewhere, will want to buy it for more than the cash in the till. Even if they just offer the hard assets, I can sometimes double my money. Odds are these companies will take 12 to 18 months to turn around, but they are probably 2 to 4 + baggers. DUH!

However, when most people look at the charts of these things, take VIAN going from 70 to 4 in about a year, they get scared. Now is the time to act. If the company has a reasonable chance of survival and a good chance that it may someday turn a profit or be broken into its assets, then be forceful in your buying, but at the same time diversify into as many as you can find, just in case the market was right!

When I evaluate a company, even those that I choose not to invest in, I will give a DUH price to it. This way the research is not without merit. If the stock market decides to move the price down to “DUH”, and nothing has really changed, I will go ahead and invest. At any time this allows me to move quickly, if there is ever a severe bear market, or a market crash. Bring on the bear, or an 87-style crash, because I am ready! As the market moves over DUH, I know where I want to buy. 

PLEASE READ PART 2 OF THIS ARTICLE