In Martin Scorsese’s 2014 film, The Wolf of Wall Street, Jordan Belfort (Leonardo DiCaprio) is taught an important secret of Wall Street elite: the aim of the game is to “move the money from your client’s pocket into your pocket.”
Although based on true events, the film is, of course, fictional but it captures the core challenge that investors struggle against. Brokers do not always have our best interests at heart.
They are often hired by big corporations who want to raise money on the stock market. Towards this end, brokers produce research notes which encourage investment in client corporations. This research is often positive, but biassed and not objective. It’s rare for brokers to recommend selling a stock. Investors will often find themselves asking, ‘When do I sell?’
So what’s an investor to do?
Investors may choose to sell a stock when it becomes fully valued. But what does that mean in practice? Valuation is not a precise science. It is often subjective. There is not always a clear price which indicates a selling point. ‘Should I sell at £1.50, or wait for £1.55?’— these are questions that often trouble investors and burn up precious mental energy, especially when managing a diversified portfolio.
At some point we have to draw an arbitrary line in the sand, if anything to save ourselves from becoming like Buridan’s Ass…
For readers who may not be familiar with the parable, the paradox of Buridan’s Ass is as follows…
A thirsty donkey stands halfway between two buckets, each containing the exact same amount of water. As the donkey contemplates which one to choose, its indecision puts it at risk of dying from thirst. It would be better off making a simple, arbitrary choice. This parable is relevant for stock market investors: while we deliberate on whether to sell, we risk the share price moving against us. We also risk missing out on better opportunities.
How can we prevent ourselves from becoming the stock market equivalent of Buridan’s donkey?
My colleague, Mark Simpson, offers a rules-based remedy with clear guidance on when to get out of a position. We have tested the performance of his framework by constructing model portfolios using a set of clear-cut rules…
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