One of my favorite investment philosophies comes from a statement made by the great Warren Buffett that states “Be fearful when others are greedy and greedy when others are fearful”. Without thinking, this may sound like some old man trying to be a great philosopher saying something that has no real meaning to it. But actually it is the exact opposite.
Although sounding very elementary, I quickly realized that this statement is deeper than what many human beings can comprehend without a second or third look. In my opinion, what Mr. Buffett is saying closely correlates to a statement made by Sun Tzu in The Art of War, that states "when the enemy attacks; retreat and when the enemy retreat; attack".
Generally when the stock market is having a great year (or week for that matter), many amateur investors become greedy and are lured by the possibilities of great gains, then of course come to the conclusion that it is now the perfect time to invest. When the rest of the world starts investing at this high point in the market, the seasoned investors generally retreat, as it can be said that the amateurs are now attacking. Although they attack with no real substance and can be defeated at any time, it is always better (easier) to destroy the enemy once they are in your territory, and thus out of their element.
Most amateur investors don’t understand market and economic cycles, let alone P/E ratios or Earnings per share data, but still you have millions of amateur investors in the stock market each year, whom nonetheless retreat once they realized that they are out of their element. They realize that they are out of their element once they begin to see massive loses, and can’t figure out why.
Now don’t get me wrong. We all lose sometimes, but when you lose and can’t figure out why you’re losing, that is a sign that you are out of your element, thus a place where you don’t need to be.
Once the amateur investors start retreating (selling off their investments below market value), the seasoned investors follow Sun Tzu’s advice and attack. When they attack, since the enemy is outside of their element and in the seasoned investors territory, the blow is fatal and often financially advance the seasoned investors, while setting the amateur investor back to a place where he or she did not want to be.
When the stock price starts to decline, the amateur investors start selling their investments at very low prices, which gives all the seasoned investors a chance to buy back their investments that they originally sold to the amateur investors when the market was at a peak, now at very low prices.
The way it works is this: the rich sell for $8, which means the poor buys for $8. Then when the stock price decreases to $6, the amateur sells it back to the rich, who of course now pays $6 for it back. Then when the stock price goes back to $8, the rich sell it to the poor again, which means the poor pays $8 again. Then when the price decreases back to $6, the amateur gets nervous again and sells it back to rich for $6.
Believe it or not, this happens all the time and is one of the many reasons why the rich get richer and the poor get poorer. This is one of the main reasons for the need for education in the fields of business and investing.
[ This article is extracted from www.gurufocus.com ]
