Celebrate Opposing Views
Ian Wyatt | SmallCapInvestor Daily | March 3, 2010
Do you think you are smarter than the masses? How tempting it is to think that as individuals we can make better decisions than groups. In 2004 New Yorker columnist James Surowiecki released his book, The Wisdom of Crowds. The point he makes in the book is that large groups of independent decision makers are collectively smarter then individuals. Surowiecki raises a number of compelling points, and his argument holds water in the theoretical world. But we don't live in a theoretical world.
I bring this up because in yesterday's issue of Small Cap Investor Daily I wrote about the short-term inefficiency of markets and how I believe astute small-cap investors are well positioned to take advantage of market overreactions. To do this, individuals need to act counter to the trend. Or at least they need to lead the crowd by buying shares of companies after many others have sold them and driven the price down.
The basis for individual advantage arises when groups of investors are all moving in the same direction, either simultaneously purchasing or simultaneously selling shares of the same stock because of publicly announced events. Often times, investors react more to what happens to the share price of the stock in question, then the actual event that causes the stock to move. In these situations, investors stop acting as individuals and begin acting as a crowd. At this point, individual decision making goes out the window, as does Surowiecki's claim that crowds are smarter than individuals. Basically the crowd becomes a stupid mob.
Surowiecki admits this. In fact this is what he has to say on the stupidity of crowd mentality (click here to check out his website):
"Essentially, any time most of the people in a group are biased in the same direction, it's probably not going to make good decisions. So when diverse opinions are either frozen out or squelched when they're voiced, groups tend to be dumb… For instance, that's how we get stock-market bubbles, which are a classic example of group stupidity: instead of worrying about how much a company is really worth, investors start worrying about how much other people will think the company is worth. The paradox of the wisdom of crowds is that the best group decisions come from lots of independent individual decisions."
Because of this paradox, I love it when readers write in and demonstrate that they are evaluating companies based on their own analysis, not just on what I've written here in Small Cap Investor Daily. At the end of the day you're the one pulling the trigger and buying (or selling) shares in a particular company. That means you need to think for yourself, and be accountable for your own actions.
***I received two emails yesterday that so clearly demonstrate the spectrum of individualism, and critical thinking, that I had to include them today. Both relate to my coverage of Republic Airways (NASDAQ: RJET), a beaten down airline stock that has risen 14.2% since I covered it last Monday. This is what one reader has to say:
"I would hardly say you were bullish in that article about RJET so saying you recommended it is a flat out "buy recommendation" is a stretch. In fact you made some of the most negative comments that I had read about RJET during that time period. It actually made me second-guess my earlier investment at under $5 a share."
While I thought I was pretty clear in stating it was a good time to pick up shares in Republic Airways, I didn't include this comment to debate that. More importantly, I'd like to point out that my critique of the company led this reader to reconsider whether the stock was a good. This is exactly the kind of reaction I wanted to generate. It's pretty easy to paint a rosy picture of a company, all dressed up with promises of huge gains to come. But that's not always the reality - companies face a lot of competitive threats. Investors need to be aware of them, and accept the risks when owning shares.
Another reader wrote the following:
"I…feel [Republic Airways] has a lot of potential. I have never jumped on stock like this. I read your article and set up a…account and purchased [a number of] shares. It wasn't at the lowest but I have profited and hanging on. It is a little nerve racking."
This reader clearly thought my review of the company was bullish. Enough so that he/she felt motivated to go out and establish a position in the company's stock.
***What's even more interesting about the comments above is that they both demonstrate the emotional aspects of individual investing. The interplay between a desire to make big returns and a reluctance to lose money basically boils down to the human emotions of fear and greed. The constant tension of these two underlying emotions factors into the individual investor's decision making process, as we've seen above.
The point I'm driving at with this psychological discussion is this: recognize that as individuals we make emotionally charged investing decisions that are often based on what everyone else is doing. Then use this awareness to evaluate potential investments that work for you. My goal with Small Cap Investor Daily, and Small Cap Investor PRO, is to lead you to great potential investment opportunities. And to educate and empower you to make individual investment decisions.
But the rest is up to you, and I want you to make responsible decisions based on your own situation. Don't try to make a killing by putting all of your money in one stock. Don't expect to get rich by investing in small-cap stocks overnight.
Emotionally driven investing based on crowd mentality is a powerful thing, and potentially dangerous when it overcomes individual decision making. As Surowiecki points out:
"…we can look to collective decisions—as long as the groups are diverse, etc.—to give us good predictions. But the collective decisions will only be smart if each of us tries to be as independent as possible. So instead of just taking the advice of your smart friend, you should try to make your own choice."
I'm glad that readers have been able to profit from our collective review of Republic Airways so far. And I still believe more gains are to come from this beaten down stock.
