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The Intelligent Investor by Benjamin Graham

Chapter 8: The Investor and Market Fluctuations

This chapter deals with the concept of market fluctuations and how the speculator or investor should react to them. Mr. Graham advises the investor that she should understand that a portfolio of common stocks will fluctuate in price over a period of time, sometimes dramatically. He further advises that the investor must be psychologically (and financially) prepared for these occurrences. Investors need to understand that short-term fluctuations of the stock market don't make them richer or poorer. They also need the right physiological makeup to avoid what the crowd is doing and be able to watch their portfolio drop in price dramatically without taking irrational actions.

If the investor is prepared for the fluctuations in market price of his holdings he can take advantage of bargain pricing on these holdings. The market is not rational and will from time to time offer you a price that does not reflect the value of a business. Think of owning shares as if you were a part owner of the business, as a silent partner you have the option of selling (or buying more of) your part of the business whenever the market is open. He also has the advantage of not acting on this quote when he has a different idea of the value of the business.

The investor can try to profit from these swings in market pricing in one of two ways, timing and pricing. When an investor is trying to time the market he is in effect saying he can predict what the market is going to down beforehand. When an investor tries to profit from pricing she is trying to purchase part of the business at a price below intrinsic value and then sell out when the price quote from the market rises above that valuation.

If timing is the path a person chooses he will end up with speculative result. Mr. Graham gives a distinct warning that following the direction of Wall Street when trying to time the market will not lead the general public to profits.

Mr. Graham discusses the question of purchasing stock in a business after its market price has declined drastically and selling it after a big advance. The point is who knows when a stock is at its lowest point or conversely its highest point. This is in effect just another form of market timing. The investor's evaluation of what the company is worth should be the prime consideration when any portfolio changes are being considered.

Speculators are not using time to their advantage; investors understand that timing is not critical to the investment process unless it coincides with attaining more of a great business at an attractive price. Investors who let themselves be at the mercy of the crowd (by using margin for instance) are turning an advantage of being able to sell shares when they believe the time is right into a disadvantage. These investors would probably be better off not having a market to provide him with quotes on his share of the business at all.

Mr. Graham also gives his readers a warning on the dangers of following trading formulas (for instance the Dow Theory). The formulas become popular when they have been shown to generate above average returns over some past time period. When these formulas become popular with the investment public they fail for two reasons; the passage of time changes factors that are used in the equation and their own popularity destroys the chance at market beating returns.

As an added consideration towards the end of this chapter Mr. Graham advises that good management should provide shareholders with a good average market price. Of course they are not responsible for fluctuations in price that have no relation to the underlying business.

I will leave the reader here with several quotes from Mr. Graham from this chapter of The Intelligent Investor.

"The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention only to the extent tat it suits his book, and no more." - page 106, 4th Revised Edition

"The moral seems to be that any approach to moneymaking in the stock market which can be easily described and followed by a lot of people is by its term too simple and to easy to last" - page 100, 4th Revised Edition

"Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop." - page 110, 4th Revised Edition

Last but certainly not least, be sure to read the famous story of Mr. Market on page 108.
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