The Emotions of Risk

One book that I frequently recommend is Justin Mamis' The Nature of Risk: Stock Market Survival and the Meaning of Life (1). I believe this book to be foundational to new traders because it discusses, what else?, the nature of risk in the market. What I love about Mamis' book is the unique way that he writes about market risk, and the way that he juxtaposes two seemingly opposing ideas, that are not in opposition at all. From that juxtaposition he illuminates. (Read on for an example). I wanted to do a brief post on some of his concepts from Chapter 6, The Emotions of Risk. I think that some will find some resonance. I particularly wanted to share some of these concepts that might engage your brain into thinking about risk differently. Mamis posits:

"Under pressure, emotions determine our action." (p. 72)

Because risk is typically defined as a peril, fear is one of the primary emotions. "Fear is long-term, an underlying pervasive emotion, like the underlying primary trend of a bear market. It doesn't go away until it changes." (p.73) Mamis makes a simple, yet powerful, statement about the pervasive fear needed for stocks to go up. Yes, you read that...to go up. For there to be buyers, there must be sellers. And it is the fear of the sellers that creates the proverbial wall of worry to provide supply for those who have a different perception of current market risk. He also notes that the operative portion of fear is anxiety. Anxiety is what paralyzes and prevents you from taking action. It is this anxiety that "gets in the way of taking a risk."

The flip side of fear is the emotion of greed. The operative emotion of greed is envy. Mamis notes that ". . . whereas anxiety paralyzes, envy cause one to act. . . " It is difficult to see the spectacular trades/success of others, and not feel a small bite from that evil twin of jealousy, envy. Envy can cause very risk behavior which is simply, "the risk of 'denial of risk'." Both greed and anxiety often lead to doing the wrong thing. Inertia can be one of those 'wrong things': failing to buy when one should buy; failing to sell when one should sell.

These emotions and their operative manifestations into our action (or inaction) govern all market participants. The impetus for buyers/sellers is reversed in bear/bull markets. Regardless of the market participant regalia you dress in each day, it is best to understand both your own and others' motivations and perceptions of the current risk environment. Mamis' book came along for me when I was feeling 'inertia'--that inertia having been brought about by the overwhelming need to have more information, more certainty, more sense of direction. Granted, there is nothing wrong in standing aside when there is great murkiness...but my inertia was spanning a time when there was some market direction, AND my emotional state prevented my seeing that. Providence must have set this book into my hands, because it helped me come to terms with that inertia.

As market participants, we have to balance the two opposing points off view of being free enough to take risk and while not falling into the trap of 'the risk of 'denial of risk.' I'm not going to leave you with that concept in a void. How does one find the right action in that balance?

We need, we crave, the trust and belief from others, but when information is insufficient we need trust and belief in ourselves. We need the discipline to accept whatever is available, and the experience to understand all the ifs, ands, and buts, and yet still take the risk: we need to be able to make the decision. (p. 79).

As with most things, the right-rootedness of these important concepts is discipline. My distillation is that we need discipline first to ensure that our trading/investing capital lasts long enough to give us the experience that we need to build mastery. Without experience, we cannot build mastery. It is mastery that produces intuition and insight, and those ultimately support our confidence. Mamis notes:

Discipline means choosing what to do unencumbered by the fear of making a mistake. Confidence means trusting our intuition and that what we 'see' is what we "know." (p. 80)

He closes his chapter with a question that I hope that all of you embrace as your own mantra for coming to terms with this concept of risk: "How do we create within ourselves the heroic condition of confidence wherein risk is not a danger but life?" (p. 80) I also implore (v. suggest) you to get this book. I promise you that it will make you think of and about risk in a way that you may not have considered previously. I particularly recommend it for any who are feeling inertia and feeling compelled to have more information, more certainty, more (this, that, the other) before forging ahead and making a decision.

(1) Mamis, Justin The Nature of Risk: Stock Market Survival & the Meaning of Life. Flint Hill, VA: Fraser Publishing, 1999

The Nature of Risk

Google books on line has several out of print books that you can get. You know one of my favorites is Selden's Psychology of the Market. I think I'll go through that again today by the fire.

Anyway, this one came from Gold Bricks of Speculation byJohn Hill, Jr. of the Chicago Board of Trade. (1904). It is helpful to read these long forgotten words to remind ourselves that there is truly nothing new in the world, and people cheating other people is a timeless preoccupation of humankind.

Fraser Publishing has a number of these books for a reasonable price. I recently finished Justin Mamis's The Nature of Risk: Stock Market Survival and the Meaning of Life. It is a delightful book about the market and the rather twisted ways in which our psychology perceives risk. In reading the forward, he mentions Helene Meisler who write TA for Real Money. I wrote her a brief e-mail mentioning how much I enjoyed the book. She said that Mamis was the best mentors that a person could have. He is in his eighties now. How delightful it must be to have your mentor call you out as being a "helper along the way" to his/her own understanding.

As I move along in seeking to diminish the perplexedness out of my own investing, I've found that the less I think, the better I do. I say this, though, having spent a good bit of time in forging my own understanding of stock market stuff--and developing a bit of 'doing without thinking' which is rather firmly rooted in doing a lot of thinking, doing, falling down, getting up and getting kicked in the stomach, arse, and having my ears boxed by the market. It's called building competence.

I have to compare my investor education to the exquisite trade of a blacksmith. With only fire and brawn and a rhythmic pounding of his hammer, he takes unformed metal and makes it into wondrous things of both elegance and utility. I'm pushing for both elegance and utility in my own investor education. The fire is my own desire to understand this 'stuff' and the brawn is simply my dogged tenacity in reading and acquiring the tools to be successful and applying those tools in an environment of uncertainty (risk).

Mamis is a market technician's technician. He believes that the market has its own language and uses technical analysis to listen to what the market is saying. He reminds that the market is designed to fool the most people most of the time. I believe him.

He writes

The value of technical analysis in the stock market is to reduce risk. It is especially helpful in guiding you to believe what otherwise seems unacceptable. By extension, therefore, it is most helpful at identifying significant market turns, both for the market and for individual stocks. . . . Stock charts and the indicators are like doctors' advice: exercise, diet, reduce stress, and so on. They are a means of establishing imperfect but relatively objective ways to understand market risks and market choices. (p.13)

This book reads more like an engaging philosophical treatise that doesn't mention words such as phenomenology! Also, his writing is fluid and engaging, and the book is liberally interspersed with real nuggets of practicable wisdom. I'll likely read it a couple of more times. What is particularly helpful is his discussion about ultimately you have to make a decision to act (buy/sell/hold) within a context of having incomplete (in all of its manifestations) information.