No 1 rule in bear market decision making: Decide when to Decide

In my earlier post here, I had discussed on how a “what-if-things-go-wrong” plan helps you preload your decisions and reduce the no of decisions during market fall.

Since this thought process has evolved only recently for me, I have not really got the chance to test it out as I am waiting for the next fall.

As always I have my doubts as to –

What if this is just some fancy intellectual gyaan?

Let us use history as a guide and check if this makes practical sense..

As mentioned earlier, the primary objective is to –

Reduce the number of decision points during a market fall

Let us check if our plan helps in this endeavor.

So let me time travel back by 28 years (since Nifty Index was started) and check on how many decisions I needed to take when markets started to fall.

In the above chart the orange line represents the % fall of Nifty from its previous peak value on each and every day for the last 28 years. This is called draw down chart.

But here is something that will shock you:
In the last 28 years, for 94% of the days Nifty was down from its previous peak!

That simply means I will almost, always have to go through the retrospective feeling “If only I had sold earlier..”.

Here is the killer – Along with it the decision on “Will the market go down further?” will also need to be taken on 94% of the days!

Earlier, I had always believed that markets were too volatile and decisions have to be made real time – each and every time the market went down. The decision could be anything – to reduce/exit equities, to buy more, to hold etc.

Now to put that in context, that meant in the last 28 years I would have had to make ~6482 decisions as for 6482 days out of 6893 days the Nifty draw down was negative !

Take a pause and get that number into your head – we are looking at around 7000 decisions over the next 30 years. Phew.

Ok. To take a decision for each and every minor fall is stretching it too far. Let us say, we need to take a decision only when the fall (read as fall from previous peak) is more than 10%.

Any guesses on the no of decisions?

4171 decisions in the last 28 years. That is almost 150 decisions every year!

What if its only for a fall above 20%?

Still we are left with 2734 decisions.

Now you get the gist.

Too many decisions..

The moment we start looking at each and every fall as a decision making point, it becomes extremely stressful as the near term is always uncertain and there is nothing much you can do about the how the markets should behave.

Further, the more the number of decisions we need to take, the higher is the possibility of panicking out of the market.

Deciding when to decide..

Let us check how our new approach of reducing the decision making points to 10%,20%,30%,40%,50% would have fared.

There have 19 instances in the last 28 years where, the bare minimum 10% drawdown trigger has occurred.

Out of 19 occurrences, only 3 times did the 10% drawdown actually get converted into a 50% fall. This means a 50% fall is a very rare event and in the next 30 years going by history we might see only 3-4 of them.

Similarly, only 9 out of 19 times has the 10% drawdown actually become a 20% correction. 

So the takeaway for us is that – a 10% drawdown is too common while a 50% is too rare.

So let us keep our decision making points to 20%,30% and 40% fall.

This implies in the last 28 years, our decision making points during a market fall has been dramatically reduced to 9 periods and just 20 decisions !

So our strategy of “deciding when to decide”  does make sense.

Summing it up..

Hence our “What if things go wrong plan” will have

  • 20% fall
  • 30% fall
  • 40% fall

as our decision making points..

Now we are left with the interesting second part – preloading decisions for these 3 scenarios.

How do we do that?

Hang on for the next part..

If you loved this post, do share it with your friends and don’t forget to subscribe to the blog via Email (1 weekly newsletter) or Twitter along with the 5000+ awesome people. Look out for some fresh, super interesting investment insights delivered straight to your inbox.

If in case you have any feedback or need any help regarding your investments or want me to write about something, feel free to get in touch at rarun86@gmail.com

You can also check out all my other articles here

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments






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A guilty father who shot his own kid, ancient Greek philosophers, US Navy Seals and the art of handling a market fall

In our last week’s post here we had explored how a small almond shaped component in our brain called the amygdala is the main culprit behind why we panic during an equity market fall.


Photo courtesy: http://www.wiredscience.com

But can the amygdala be this powerful?

Hold your breadth.

It made an innocent father kill his own child.

Source: https://classic.esquire.com/article/1995/3/1/the-right-to-bear-sorrow

Startled Father Fatally Shoots His Daughter

It was the November of 1994..

Fourteen-year-old Matilda Kaye Crabtree was hiding in a closet, playing burglar. Her father Bobby Crabtree, who didn’t know she was home, pulled open the door with gun drawn.

“She went, `Boo!’ and that scared him,” said Stacy Redding, who crouched with her friend in the closet, and then watched as Robert Crabtree fatally shot his daughter in the neck.

Kaye’s last words to her father: “I love you, Daddy.”

You know who was the real killer.

As a fear response, Bobby’s amygdala had kicked in and his body reacted way before he could be conscious of what he was doing.

While Bobby was not prosecuted as what had happened was an accident,  you can imagine the pain this father had to live with throughout his life.

The lesson for us is clear – Don’t underestimate the amygdala!

So, what if we removed the amygdala?

But hang on..not so fast

Without amygdala, the guy would never be walking again.

So doing away with the amygdala is again not an option given its ability to save us in a lot of other contexts.

We simply need to learn on how to handle amygdala and manage our fears.

Million dollar question – How do we manage our fears?

The simple yet profound answer – feeling in control.

The most powerful way we can cope with fear or anxiety is to create a feeling of control

Anything that gives us a feeling of control over our situation helps us keep our calm. But when we don’t have a feeling of control we get stressed and start panicking.

Our prefrontal cortex in the brain is where we do all the “thinking”.  As long as we feel in control, we can use it.  When we feel out of control, we lose the ability to think from our prefrontal cortex.

Amy Arnsten studies the effects of limbic system arousal on prefrontal cortex functioning.  She summarized the importance of a sense of control for the brain during an interview filmed at her lab in Yale.

“The loss of prefrontal function (the thinking part of the brain) only occurs when we feel out of control. It’s the prefrontal cortex itself that is determining if we are in control or not. Even if we have the illusion that we are in control, our cognitive functions are preserved.”

This perception of being in control is a major driver of behavior.

Your Brain at Work by David Rock

So how do we bring in a feeling of control?

Let us check other fields which have the same problem and find out how they are solving it. This will give us some valuable clues.

Think of army men, bomb squad members, firemen, emergency ward doctors etc who are trained to make good decisions in extreme high pressure situations.

Let us study the most badass amongst them..

Enter the US Navy Seals..

The US Navy seals have handled threatening missions in the world’s most dangerous spots, whether that meant jumping out of airplanes, taking down hostile ships in the open sea, or rolling prisoners in the dead of night in the mountains of Afghanistan. As a Navy SEAL, they have learned how to manage the natural impulse to panic in the face of terrifying situations.

1.Prepare and Practice

 If you are wondering on how the Navy Seals are so fearless, the simple answer is they – Train, Train, Train!

“We spend 75% of our time preparing for deployment and about 25% on the deployment.” 

“It’s not like you jump out of a plane once and then you remember how to do it forever. It’s something you’ve got to constantly revisit. When you hang out in the mountains of Afghanistan, you don’t exactly get to work on your scuba diving.”

Former SEAL Commander James Walters

The SEALs learn to handle fear by practicing all possible high pressure situations well in advance repeatedly until they feel naturally confident about it—until that unknown becomes, well, a little more known. This provides them with a sense of control and confidence.

In the SEAL teams, this is called contingency planning.

What will we do if we hit a landmine?
What will we do if we take a casualty?
What will we do if the target house looks like it’s been abandoned?

Even NASA followed a similar strategy for their astronauts to make sure that astronauts wouldn’t panic in the early space missions. They ran them through every step of the process until it became boringly familiar. This level of familiarity produced a powerful feeling of control and confidence.

Before the first launch, NASA re-created the fateful day for the astronauts over and over, step by step, hundreds of times — from what they’d have for breakfast to the ride to the airfield. Slowly, in a graded series of “exposures.” the astronauts were introduced to every sight and sound of the experience of their firing into space. They did it so many times that it became as natural and familiar as breathing.

Obstacle is the Way by Ryan Holiday

Now, if you really think about it – almost everyone be it a surgeon, a fireman, a bomb squad member etc who is required to deal with decision making in high pressure situations inevitably goes through thorough preparation and training.

But when it comes to investing in equities, most of us enter completely oblivious to the power of our amygdala – unprepared and untrained to handle a bear market.

Even experienced investors have gone through their share of tough periods and most of them over years have evolved their ability to handle bear market mostly via trial and error and repeated exposure.

Usually a correction of 40-50% happens every 7-10 years while a 20-30% happens every 3-5 years. This means by the time we get prepared to handle a bear market via actual exposures it is almost 15-20 years. That is too long a training period.

So the question for all of us is –

How in the world do we train for a stock market correction?

While I don’t have the perfect solution yet (and I guess a lot more attention is desperately needed here), here is a good starting point to train for a market fall

  1. Reduce the no of decision making points – pre decide when you will actually make a decision
  2. Prepare a “What if things go wrong” plan – write down what you will do if your portfolio is down 20%,30%,40% and 50% (also think of the various declines in portfolio in Rs terms (vs % terms). A 10% fall, on a 1 lakh portfolio feels a lot different than on a 10 cr portfolio!)
  3. Reduce the frequency of monitoring your portfolio
  4. You can also refer my earlier posts on this topic for a detailed explanation

2. Long Term Goals as a sequence of short term goals

This was one among the most important techniques which the Navy Seals used to increase their passing rates during training.

To maintain a feeling of control, during an extremely stressful situation the Navy SEALs often thought about their friends, family, religious beliefs, and other important things from their lives. The key was to see something positive in the future (in the near future, if possible) that allows the mind to be distracted away from the current stress and uncertainty.

They also broke down their goals into micro goals, short-term goals, mid-term goals, and long-term goals.

Instead of thinking of completing the six month training course as one goal, they broke down the six months into weekly goals, daily goals, hourly goals, and even goals by the minute. 

Short-term micro goals coupled with longer-term goals was their strategy

We can apply the same strategy while investing.

Goal Based Investing is a practical way to implement the above concept where your investments are bucketed according to their purpose (goals) and when you will need a given amount.

The purpose of “why” we are investing is often forgotten during a falling market. It makes sense to remind our self of the original goal for which we are investing (to become financially free, start a new venture, fund kid’s education etc) and the actual planned time frame. This helps to get a holistic picture and distract ourselves from the temporary market fall.

Further, a micro focus on short term things under our control – continuing to invest one month at a time and sticking to our “what if things go wrong” plan after every 10% fall also helps to stick to our long term plan.

3.Stoic Philosophers to the rescue

In ancient Greece and Rome, many prominent thinkers & philosophers subscribed to a philosophy called Stoicism which is primarily about recognizing what you can and cannot control, in order to focus your energy exclusively on what you can actually control.

Source: https://dailystoic.com/premeditatio-malorum/

The ancient Stoic philosophers which includes the likes of Marcus Aurelius, Seneca, and Epictetus regularly conducted a strange exercise known as a Premeditatio Malorum, which translates to a “Premeditation of Evils.”

Now before you get scared, “Premeditation of evils” was simply a practice of taking a moment to think through everything that could go wrong with a particular plan and prepare for it.

This may sound extremely pessimistic and counter intuitive, but the Stoics believed that by imagining the worst case scenario ahead of time, they could overcome their fears of negative experiences, make better plans to prevent them and lessen the impact of the negative outcome if it ever translates.

While most people were focused on how they could achieve success, the Stoics also considered how they would manage failure.

What would things look like if everything went wrong tomorrow?

And what does this tell us about how we should prepare today?

Source: https://en.wikipedia.or/wiki/File:Samurai_with_sword.jpg

Even the Japanese Samurai warriors used to think about death a lot. Why? That way they wouldn’t fear it in battle.

One who is supposed to be a warrior considers it his foremost concern to keep death in mind at all times, every day and every night, from the morning of New Year’s Day through the night of New Year’s Eve.

The Code of the Samurai

Really thinking about just how awful things can be often has the ironic effect of making you realize they’re not that bad.

Here is an interesting story which I came across from a presentation by an amazing blogger called Jana Vembunarayanan.

This is what an experienced investor from India recent told me. He has been operating in the markets for 30+ years with a CAGR of 35%. During 2008-2009 his portfolio was down by 80%. Apart from his property he had most of his net worth invested in equities.

How did he sleep well at night?

He had the habit of mentally counting only 20% of his net worth.

This helped him a lot to stomach the drawdown.

https://janav.files.wordpress.com/2018/10/three-bucket-framework-to-investing.pd

This is a great way to think about your existing portfolio.

As equity investors, we will all have to experience a 40-50% drop in our equity portfolios at some point in time. 

What if we, like the ancient stoics mentally wrote off and counted only 50% of our existing equity portfolio.

What would things look like if this happens tomorrow?

What if the market never recovered – will we still be ok?

The answer to this will also decide our equity allocation.

Like the stoics and the experienced investor from India, practicing the habit of mentally writing down a part of the portfolio will help us be a lot more prepared and better positioned to handle the inevitable bear market.

Summing it up

Never underestimate the ability of the Amygdala to overrule your rational brain in times of panic. The key is to acknowledge and work along with it.

Here are few techniques we can learn from the Navy Seals, NASA, the Samurai warriors and the Stoics to handle a market fall without panicking

  • Plan and Pre-load your decisions for a falling market
  • Reduce the no of decision making points – pre decide when you will actually make a decision
  • Prepare a “What if things go wrong” plan – write down what you will do if your portfolio is down 20%,30%,40% and 50%
  • Reduce the frequency of monitoring your portfolio
  • Long Term Goals are a collection of short runs – combine the “why of investing” with the discipline of regularly investing one month at a time and sticking to the “what if things go wrong plan” for every 10% fall
  •  Practice mentally writing down a part of the portfolio

If you loved this post, do share it with your friends and don’t forget to subscribe to the blog via Email (1 weekly newsletter) or Twitter along with the 5000+ awesome people. Look out for some fresh, super interesting investment insights delivered straight to your inbox.

If in case you have any feedback or need any help regarding your investments or want me to write about something, feel free to get in touch at rarun86@gmail.com

You can also check out all my other articles here

Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments