Wall Street’s Biggest Fear

There’s an old Bob Dylan song about the Cold War that has the chorus “Let me die in my footsteps before I go down under the ground.” Back in those days, many Americans’ biggest fear was nuclear annihilation, and fearful families built underground fallout shelters and lived in a constant state of paranoia about an imminent Soviet attack. But, as we all know, the worst-case scenario, the so-called “mutually assured destruction,” never happened.

I talk many times on Trading Common Sense and in my book about the importance of controlling emotions and maintaining a very stoical view of your stock portfolio. But I believe that fear is the hardest emotion of all to keep pinned down. We have such a deep-rooted, primal craving to stay safe that fear is an extremely gripping sensation. But there’s a particular type of fear that is the absolute worst kind.

A movie where the protagonist is being chased by a chainsaw-wielding bad guy can certainly be scary. But for my money, a movie where the protagonists is being terrorized by a ghost, an alien, or a monster can be much more chilling. Why is that? It’s because I understand what a human (and a chainsaw) is. But I have no idea what that screaming, snarling, winged creature with the glowing red eyes lurking in the shadows of the swamp is. Screw that thing!

But I know good and well that chainsaw dude can probably kill me just as easily and swamp beast. So why is that thing so scary? It’s because I know absolutely nothing about it. When your mind is left to fill in the informational blanks, is has nothing to use to do so other than emotion.

chainsaw guy
Figure 1: Scary, but no swamp beast.

In my book, I talk about what I did when I first realized that investors’ biggest fear was not bad news, but rather uncertainty, or the unknown.

On Friday, April 24, 2009, I was as uncertain as everyone else about the short-term success of the banks. I did not know whether or not Bank of America or Citigroup would pass the stress test, or if the Federal Reserve would require them to raise additional capital. However, one thing I did know was that the results of the stress test would be released in early May. And I knew that as soon as the results were released, every single person with a TV, a computer, or a newspaper that was previously uncertain would then be certain, one way or another. My idea was that the 19 banks being tested were trading at the time as if they had already all flunked the stress test miserably. Even if all of the banks failed the stress test and needed more capital, investors would have a sense of relief because the uncertainty would be gone. In my mind, good or bad, the stress test results would provide clarity that would eliminate the fear of owning bank stocks.

                I decided to try to trade my idea… I wanted to own another bank, I wanted it to be one of the 19 banks being stress tested, and I wanted it to be as different as possible from Citigroup and Bank of America. I decided on Fifth Third Bancorp (FITB)… the important thing to remember was that, in my mind, there was no wrong answer.  I believed that each of these 19 banks, no matter how bad the test results, would likely see a rise in share price after uncertainty had been eliminated.

                On Monday, April 27, 2009, I bought shares of FITB at $3.64 per share… On Thursday, May 7, the Federal Reserve released the results of the stress test. Ten of the 19 banks “failed” the stress test, indicating that they would need to raise additional capital. Among the flunkees were C, BAC, and FITB. Fifth Third needed to raise an additional $1.1 billion dollars, which was a lot of money for a relatively small regional bank. So what happened to my bank stocks? The week of the stress test results, C and BAC jumped over 30 and 60 percent respectively! And FITB? My FITB shares rose a whopping 110% in one week! All of these banks had “failed” the stress test, but the results were not the end of the world, and investors were relieved to see some light being shed on the situation… On Friday, May 8, less than two weeks after I bought my FITB shares, I sold them for $7.28… exactly TWICE what I paid for them!

When investors are uncertain, their fear takes hold of them and they behave irrationally. Their imaginations run wild, and they make absurd assumptions. There is a difference between preparing for the worst-case scenario and assuming that things will be much worse than you could ever imagine. 

It’s funny listening to CNBC today and hearing the explanations about the political and economic reasons the S&P 500 is down nearly 25 points so far today. I told my wife yesterday that today would probably be a bad day for the stock market, and it has nothing to do with China, Russia, President Obama, or the weekly jobs report. I believe it has to do with one guy in Dallas that was diagnosed with a horrifically deadly and highly contagious disease. Ebola is no swine flu. The mortality rate is upwards of 50%. That’s scary to people.

I don’t think the typical person knows quite what to make of how dangerous ebola really is, and that uneasiness is being reflected in the stock market. As for me, I’m enjoying ebola’s collateral damage to Amazon‘s stock, as the share price is now well below the $324 price at which I initiated my short position. And my mouth is watering watching the share prices of the stocks on my watch list plummeting, as about half of my portfolio has been cash for a while.  But as far as Apple, Bank of America, Melco Crown Entertainment, and all my other long positions, I have no plans of selling any of them any time soon because of ebola. Let me die in my footsteps…

Want to learn more about the psychology of the stock market? Or maybe you just want to be able to look sophisticated in front of your coworkers when they ask you what you are reading on your Kindle, and you’d prefer to tell them “Oh, I’m just reading a book about stock market analysis,” rather than the usual “Oh, I’m just looking at pics of my ex-girlfriend on Facebook.” For these reasons and more, check out my book, Beating Wall Street with Common SenseI don’t have a degree in finance; I have a degree in neuroscience. You don’t have to predict what stocks will do if you can predict what traders will do and be one step ahead of them. I made a 400% return in the stock market over five years using only basic principles of psychology and common sense. Beating Wall Street with Common Sense is now available on Amazon, and tradingcommonsense.com is always available on your local internet!