Make a fortune by getting out too soon

The advantage of seeing things before other investors is that you are able to capture the sweet spot in a trade, and then get out before things go a bit crazy. This can often be the movement in price from “don’t touch that thing with a barge-pole” in which everyone is sure it’s going to crash and burn, to merely “it’s still crap”. It’s more often the middle of a trade where momentum builds and new money comes in that the real money is to be made. It’s at that point which many investors who got in early start to get nervous and bale out.

The disadvantage of seeing things early is that you are prone to missing out on much of the blow-off top, this last part of the trade where other investors are panicking that they are too short. At this point of course the early rational investor still in the market is hoping that they are not the greatest fool.

“I made a fortune getting out too soon.” – JP Morgan

In this series of articles I’ve quoted a number of passages from commodities guru Jim Rogers. Roger’s often talks about his weakness as an investor is being too early – both entering and exiting an investment. He sees the fundamental shift before others do, but then typically exits an investment before its allowed to develop into that euphoric end stage. He sees things that everyone else is blind to – that euphoric markets always end in disaster, especially for the investor left holding the bag. Roger perhaps makes the mistake of believing that just because he can see it, then the investing mob can also see it and will react accordingly. Here’s a perfect example from Roger’s experience investing in the late 1970’s bull market in energy (emphasis my own):

“In 1970 crude oil sold for under $3 a barrel. Most experts believed that the price would remain low for the foreseeable future…Careful research, however, showed that our supply of oil could not possibly meet the world’s increasing demand. Basic Economics 101 told you that crude oil prices were destined to rise considerably. Accordingly, I invested in oil around 1971. Ten yeas later, oil was up to $35 per barrel. By then of course, everyone was investing in oil (including the same folks who had underrated its value). Clearly, the market had overheated…In 1978 oil production actually exceeded consumption for the first time in years. I sold my shares and did not buy oil again until 1998.”

What I find so fascinating about the quote isn’t that Roger’s bet against the consensus, and then sold before the market got too overheated. No, what fascinates me is that he was able to leave the oil market alone for two decades. It was only in the late 1990’s that he recognised that the same bullish conditions were in place as those he had observed in the early 1970’s, i.e. a strong developing demand/supply imbalance dismissed by the majority of investors overcome by extremely negative sentiment.

Too often we leave the party too early, only to hear that our friends have had a great time while we’ve been waiting in the cold for the bus ride home. That FOMO then draws us back in even though the odds are no longer in our favour. Seeing your friends and neighbour’s getting rich (at least on paper) is a powerful elixir, drawing you back into a market that you had so triumphantly exited days earlier. Isaac Newton being drawn back into the South Sea Bubble after cashing out early is perhaps one of the most prominent historical examples of FOMO in action.

Related article: The South Sea Bubble: 300 Years Later

“To be a disciplined investor you have to be willing to stand by and watch other people make money on things that you passed on” – Howard Marks

At least with a blow-off top the subsequent crash makes it’s clear to everyone that the bubble has burst. Much more nefarious is the bear market. The air gradually seeps out of the bubble only for the market to viciously inflate again. These frequent bear market rallies are meant to catch you out. They leave you thinking that there might, just might be life left in the bull market.

The upshot of this is that rather than trying to rekindle old glories from markets that are passed their sell-by date, it’s best to wait for the odds to become seriously stacked in your favour once more. If that means leaving a certain asset market alone for years, decades even then so be it.

This is the final post in a series of 7 articles.

Article number 1 – The Catalyst. Article number 2 – Pay attention to what others neglect. Article number 3 – Attention to detail separates success from failure. Article number 4 – The art of masterly inactive investing: Knowing when to do nothing. Article number 5 – Being prepared for market setbacks starts with sound expectations. Article number 6 – Trust the fundamentals to signal that the bull market is over

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