“Superior investment results come from exploiting the differences between how things should work and how they actually do in the real world” – Howard Marks

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According to Howard Marks, investors who take into account the psychological momentum behind big moves can often deliver higher returns.

The co-founder of Oaktree Capital Management offered advice on how to weather “market stress” and read investor psychology.

“Anyone can study economics, finance and accounting and learn how markets should work. But superior investment results come from exploiting the differences between how things should work and how they actually do in the real world,” writes the billionaire.

Here are the “most essential” components according to him:

Recognize market patterns

Marx encourages investors to study market history to better understand current events.

“Ironically, investor psychology and market cycles – which appear volatile and unpredictable in the short term – fluctuate in ways that have regular patterns when viewed over the long term.”

Understand cycles

Instead of viewing market cycles as a series of ups and downs, Marx viewed them as a series of events. For this reason, investors should view cycles as a constant shift between excess and moderation.

“Thus, a strong move in one direction is more likely to be followed by a correction in the opposite direction than a trend that is ‘skyrocketing.'”

Be aware of emotional highs and lows

The idea that a stock can make endless gains is a key signal to pay attention to, as unbridled optimism can indicate increasing volatility in the price level. Similarly, shareholders who demonstrate excessive pessimism are most likely to be willing to sell shares at any price, Marks writes.

Extreme times

“Remember, in extreme times, the secret to making money lies in opposing, not following. When emotional investors take an extreme view of an asset’s future and drive the price up to unwarranted levels as a result, the ‘easy money’ is usually made by doing the opposite.”

But that doesn’t mean going against the trend all the time, he warned. To succeed in contra trading, investors need to understand what the herd is doing and why, what is wrong with that position, and what to do instead.

For Marx, much of what happens in the markets is not the result of a “mechanical process” but changes in emotions that can be exploited. He also urged investors to resist their own emotional swings while being wary of “illogical propositions.”
When you come across a widely accepted proposition that doesn’t make sense or one that you think is too good to be true ( or too bad to be true), take appropriate action.”