The ALGORITHM that Investors need
I am confident you have come across the word “Algorithm”. If you have, you will not be surprised to know that we live in a world driven by algorithms. Computers, phones, apps, gadgets, watches, cars, Amazon (our shopping), Netflix (our entertainment) and practically everything else runs on algorithms. They can come in different names and flavours such as AI, Machine Learning, Recommendation Engines and so on. Thus, most people think of an algorithm as some complex thing meant for computer geeks. The purpose of this post was to not only bust this myth but also to help you harness the power of Algorithms as an investor.
But what is an Algorithm?
Webster defines an algorithm as a step-by-step procedure for solving a problem or accomplishing some end. I would simplify this and say that an Algorithm is nothing but a series of IF THIS– THEN THAT Statements.
You can even have an Algorithm for something as basic as boiling eggs or making tea. I make good tea though I must confess there is scope for improvement there too like in other areas of my life. You are the lucky 🙂 one to get my Algorithm for making tea. It goes as follows.
If Making Tea, Then Boil Water.
Once the Water Boils, then put in Tea Leaves (I do not consume sugar in the tea else I would have added it before this step while boiling water). You can also add Ginger or Masala at this point of time.
Once the Tea has Steeped Well in 4-5 minutes, then add Milk.
If the Tea looks and tastes Good, Then Serve the Guests; Else Order from Swiggy (I added the “Else” to make my algorithm complex 🙂 and No Swiggy is not paying me anything)
You can even make this algorithm as complex as possible but my objective here is not to make you a wiser tea maker but to guide you to become a wiser/better investor.
So, what are the algorithms that any investor needs? There are many and I will not cover all of them in this post. I will cover the most critical one today and will share some additional ones in the future. In addition, you can create your own ones on paper (yes you do not need to build an app) and use them to become a better investor.
The most critical one is the Algorithm of “Waiting for the right time to Invest or Waiting for Corrections”. The legendary fund manager “Peter Lynch” had said “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” This is the second costly mistake investors make. You cannot beat the first mistake of “buying high and selling low” that easily. However, this one comes close and it comes from the notion that people think “waiting will give them better prices”.
Waiting is not the mistake though always but the mistake is to wait more when better prices come along.
From February – March 2020, the global markets cracked anywhere from 34-45% in a matter of weeks. Even at the peak in January 2020, people were waiting to invest, and the same people were even waiting in March 2020 to invest. By the way, many are still waiting. The truth is and its almost a cliché now that markets cannot be timed with precision and even without precision, they cannot be timed consistently by anyone. Even the legendary Warren Buffett sold his stake in an Airline stock (in 2020) before the Airline stock started going up.
The markets went down by around 7-8% in the last few days. How many do you think would have invested? Why can we not invest when the markets correct? We believe it will correct some more. Our emotions get in the way. This is where Algorithms come to our rescue.
The “Waiting for the right time to Invest” Algorithm without written down rules does not mean anything. Here is a sample for you to construct.
IF the Stock Market corrects by 5%, THEN Invest 20% of liquid assets you have kept for your long-term goals.
If it does not correct in the next 15 days, THEN Invest 15% immediately and another 15% in another 2 weeks.
IF the Sensex goes to 48000, THEN Invest 20% of liquid assets not needed for the next 10 years. IF it goes down further to 44000, THEN Invest an additional 30%.
Yet another Version
IF it goes down further to 44000 in the next 15 days, THEN Invest an additional 30% ELSE if it does not go down in the next 15 days but goes up to 46000, THEN Invest 20%.
These are just representative examples and are not something you need to follow. You must build your Algorithms with the help of a Competent Professional.
The objective of these Algorithms is to remove the emotional biases that affect our investment outcomes. In short, Algorithms are effective Antidotes against Emotions. Waiting for the right bus is important but once the bus arrives, it is important to get into the bus and sit tight till you reach the destination.
In the investing world, most people jump from one bus to another bus, but many go from one bus stop to another waiting for the bus to come. The bus does come eventually but someone then screams “Leave this one. There is a golden one coming with many empty seats in it.”
We are not well wired or equipped to avoid the FOMO of missing the elusive Golden One. Algorithms and the care of a Competent Professional are our best bet.