Lingling Wu

Wed, Sep 9

Beyond Greed and Fear

When I was studying in Durham University many years ago, the Professor in Behaviour Finance class recommended the classical book written by Hersh Shefrin “Beyond Greed and Fear”. Ever since I started my career within the finance and investment arena, this name has appeared in my mind again and again, as I see evidence market participants are manipulated by these two emotions all the time. A prime example is the reaction to recent market volatility. Whilst the US Nasdaq has led the market rally, up by 87% from the March low, all I’ve heard is ”buy Tesla and Apple”; “open the account to make your retirement money”…… Greed makes people especially individual investors believe there is no highest, only higher!


However, when the market started selling off led by big techs on Thursday 3rd Sep, this followed by subsequent substantial hit on Friday and Tuesday( after labour day holiday). This meant that the Nasdaq had lost 11% from the historical high, fear becomes the emotion encapsulating the market. Panic sellers forgot to ask the driving factor for such a move. With little in the way of economic, political or trade related reasoning, the markets seemed to freefall as short-term traders and algorithms kicked in and brought stocks down sharply. The reasonable explanation is that from a natural cycle perspective, there is always a correction, if markets go to one direction too far or too long, a short-term correction is inevitable.


As a professional investor, regardless whether that is institutional or personal, the aim is to obtain steady returns based on differentiated risk appetite, and this should be the common goal. To enjoy multiple times return one month, but lose it all in the next month, is simply  speculation, not investment, or at least not professional investment.


So, are there any “Golden Rules” to be followed by professional investors, to minimize the influence of the greed and fear?


1. Keep reasonable expectations


Many new investors see trading as a get-rich-quick scheme. Although there are a number of stories of investors/traders who do make big profits in a short period, there are far more untold stories of them who wipe out their accounts in a very small space of time. Many of them then chase their losses and lose more and more over time.


It’s vital to always have realistic expectations and goals. For instance, “my annual gross return target is 12%”, or “my target on long AMD is to get 20% return over 9 months”, etc. Only when you have clear and reasonable expectations, you can make your own investment strategy and money management and trading rules.


2. Build up your own strategy based on your own investment timeline


A strategy or plan should include at least below parameters: assets allocation, timeline, leveraged or not. Everyone has different preference on underlying assets. For instance, Kylin Prime Capital is strong at selecting individual stocks and leverage option tools, therefore more than 70% of their current portfolio is constructed with equities and options. Some investors prefer utilise Forex trading as, at times it’s more active; some invest more in fixed income markets. There is no black or white, or definitive one size fits all approach, moreover, you need to understand your strengths.


Timeline is another important but easily being ignored parameter. The strategy of building up portfolios which expect to last for two years is completely different from the one for two months, as liquidity and performance of different assets are very different if timeframe is considered. Investors need to emphasize when the initial timeframe is updated from time to time, so Assets Managers can be informed to keep the portfolio updated and optimised.


3. Discipline, particularly on risk management 


Emotion can easily overwhelm investors. Greed and fear, alongside other character traits such as impatience and over confidence, can often lead to a lack of discipline. Risk management is often taken as one of the most vital disciplines to adhere to. At Kylin Prime Capital, risk reward ratio (RRR) is considered to be the golden rule which cannot be breached, regardless of invested assets. RRR at KPC is often more than 3, cannot be lower than 2. When portfolio managers enter a trade, they must set up stop loss and target which will ensure the investment will possibly bring at least 2 returns by risk 1 loss. Stop losses are not fixed, and as the markets progress positively within a trade they will be trailed alongside the move of the market to limit risk then lock in profits gained.


As shown on below chart, KPC team benefited the rally of Nasdaq to gain significant return for investors. They kept 2:1 RRR, trailed the stop loss and target 6-7 times following the market move. This position holding ended on 3rd September 2020, when the stock pulled back to hit Stop loss 7 which is also the target 6.


Chart: Long Nvida stock from December 2019 to 3 September 2020.


4. Stay alert to the market, but do not be over sensitive 


Market dynamics change over time, it requires the investors to adapt too and maybe update their strategy. More volatile markets for example, may require changing risk parameters, stop and target trail. Market awareness comes with fundamentals and experience. However, controlling your emotions is also part of training, where any change of dynamics would cause panic and fear, which remain the absolutely the enemies of a professional investor.