Applying The Intelligent Investor strategy to Football Index

The Intelligent Investor by Benjamin Graham may be over 70 years old and primarily focussed on investing rather than gambling, but many of the core principles within this book can be applied to Football Index.

Regular listeners of the Football Index Club Daily Podcast will have heard this book mentioned a number of times, especially in episodes where I have been accompanied by Index Moneyball.

Psychology of Trading

“The investor’s chief problem - and even his worst enemy - is likely to be himself” - Benjamin Graham

Self-defeating behaviour and a lack of emotional discipline are often what results in Football Index traders failing to reach their full trading potential. Everyone's psychology works different but I know from my own personal experience that it has been my own emotions and not my logic and understanding of the value of players that has led to my most poor trading decisions.

When I talk on the podcast, write these blogs or analyse players, I am thinking rationally. I consider a range of variables and attempt to objectively assess the information in front of me to provide what is usually a good judgement. However, in my own trading, I know I have sometimes made rash decisions and have failed to maximise my own returns.

This is partly why I feel it is so important for me to continue to learn, develop and understand my own psychology and share the information with members to help others avoid making the same mistakes I have made. If I had have created player reviews for many of the players I have chosen to buy or sell in the past, I am sure I would have been more profitable. A balanced, objective assessment on a player will almost always be more useful than relying on gut instincts or emotions alone, especially in a market where other traders will often act so irrationally.

So where does Benjamin Graham's The Intelligent Investor come in?

First of all, Graham's book helps to remind us of how trading can be emotionally demanding and reminds us how fallible human decision making can be. We should therefore ensure that we harness our emotions and refuse to stoop to the market's level of irrationality.

The combination of the 3 emotional responses outlined below can often contribute to wide price swings:

  1. The anticipation of profits from already identifying a pattern (A player rising in price) releases a pleasure chemical called dopamine

  2. When shares drop, the financial loss fires up your amygdala which is the part of the brain that processes fear and anxiety and generates the fight or flight response

  3. The emotion from financial loss is more than twice as intense as financial gain

What these psychological factors lead to is players becoming temporarily overpriced as people buy overvalued shares when they are rising and then shares becoming temporarily underpriced as people sell undervalued shares when they are falling in price.

We see similar price movements at times when players are in or out-of-form. Further information on the impact of recency bias can be found here.

Psychologists have shown that most of us do a very poor job of predicting today how we will feel about an emotionally charged event in the future. This only contributes to pendulum swings that go from irrational exuberance to unjustifiable pessimism.

Marcus Aurelius is full of useful quotes on discipline!
"The happiness of those who want to be popular depends on others; the happiness of those who seek pleasure fluctuates with moods outside their control; but the happiness of the wise grows out of their own free acts." - Marcus Aurelius

Enthusiasm almost invariably leads to disaster and considerable willpower is needed to avoid following the crowd, but if you are prepared financially and psychologically for wide price swings and can independently assess value for yourself, I am confident that you will beat the market.

From reading a number of comments in the FIC Discord Group, it appears that most FIC members chose not to sell into the recent drops and this is looking a very wise decision.

Price fluctuations

"Market prices provide you with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal" - Benjamin Graham

The dangers of buying into players that are rising in price

The results in the players that have been highlighted on Football Index Club have varied since the site started. But, most months the results have beaten the market by quite some way. What has always stood out when I have gone back and analysed the results has been how the worse performers are almost always players who had been rising prior to being highlighted.

"The market often happily pays more than a share is worth when they are going up and is desperate to dump shares for less than their worth when they are going down." - Benjamin Graham

The problem with buying into rising players is that by the time everyone decides that a given player is “obviously” the best one to buy, the prices of the player has been bid up so high that its future dividend yield has nowhere to go but down.

The more enthusiastic the public grows about rising share price, and the faster it’s advance compared with the actual growth in its earnings, the riskier a proposition it becomes.

One thing that I uniquely disagree with and have seen with huge support on social media in the past is checklists for players. I have seen Tweets with hundreds of likes and retweets about how players are good purchases if they have certain characteristics. For example, a player is apparently a good purchase if they:

  • 'Play a full 90 minutes regularly'

  • 'Play for a PB league team;

  • 'Have a high PB average'

  • 'Play for a strong national side''

  • 'Play for a strong team'

  • 'Take set-pieces '

I genuinely believe those who make such tweets have the community at heart and are really just trying to help. I also don't doubt that players with such characteristics may have a better chance of earning dividends.

But here's the key thing: a great share is not a great purchase if you pay too much for it.

A lot of the players with the above characteristics already have these factors reflected in their higher prices. So really the question shouldn't be, do they have these characteristics but are the player's chances of earning dividends already reflected in their price? Are they actually good value at their current price based on future dividend yields...not just future dividends.

If the predicted dividend returns start to dry up or something happens that leads to the player no longer playing for the perfect team and taking set-pieces, what is going to happen to their price?

For example, when Memphis Depay was linked to Barcelona his price dropped from around £5 to close to £3. The thought of him competing with Lionel Messi for both set-pieces and top forward led to a sharp decline. Was Depay overpriced at £5? Not particularly. And you could argue that no one could have predicted the market to decline or for him to be linked to Barcelona, but one thing is for sure... at £5 there wasn't much of a margin of safety.

Memphis Depay's price is now recovering with him remaining at Lyon

Margin of Safety

"The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. If the margin is a large one, then it is enough to assume that future earnings will not fall far below those of the past in order for an investor to feel sufficiently protected against the vicissitudes of time." - Benjamin Graham

This concept can help us pick shares that are very likely to return their price in dividends, but if X happens, could return much more than expected in dividends. One of my personal favourites on Football Index is Nikola Vlasic. Why? Firstly because I think he will return his instant sell price in dividends even if he remains at CSKA Moscow via European Competitions and International Tournaments with Croatia (Bold statement, I know) and secondly because the margin of safety is huge. The margin of safety is huge because when considering his value I am not even taking into account the possibility of a big PB move, which incidentally also looks likely. Vlasic is just one example and I can certainly see why other traders wouldn't want a Non-PB league player, but I guess my differing opinion on Vlasic's value to the rest of the market is what makes Football Index such an enjoyable and often profitable platform.

When Vlasic has a particularly wide spread I often buy more and I often sell when his price rises

Conversely, it can be easy to get caught out by buying into players where there there is a small margin of safety. Say you think a player is going to return their price if X and X scenarios take place, but they are unlikely to return their price in dividends if these future possibilities do not take place, they could be a risky hold.

Buying into players that are dropping in price

"The market is fond of making mountains out of molehills and exaggerating ordinary vicissitudes into major setbacks. Even a mere lack of interest or enthusiasm may impel a price decline to absurdly low levels." - Benjamin Graham

This quote could not be more relevant than it has been in recent weeks. The cheaper stocks get the less eager people are to buy them because they are imitating the market, instead of thinking for themselves.

One idea I particularly liked in The Intelligent Investor was that of declines in players prices being like a flash sale. Imagine the shift in trader's mentality if every time players dropped in price, they saw a big SALE sign on the player's prices. For example only earlier this month we might have seen 'Neymar 15% Discount Sale' next to Neymar's price.

Of course, this would never happen, but this shift in mentality towards value players can be a nice way of remembering that when players drop in value it is often actually a good time to buy. Fortunately, I listened to this message from The Intelligent Investor and the Neymars that I bought earlier this month are now up over 15%.

"The worse the future looks, the better it usually turns out to be." - Benjamin Graham

As mentioned in the psychology section of this blog, humans are proven to be poor at judging the future based on the present, as often our emotions will get in the way. Therefore, sometimes when you may feel that prices are going to drop further and there is a lack of sentiment amongst the Football Index community, it could be the perfect time to buy.

"After you burn your mouth on hot milk, you blow on your yoghurt" - Turkish Proverb found in The Intelligent Investor

Overall, due to fear of losing further money, confidence is often low during dips in the market and this will frequently become exaggerated to the point where players become extremely valuable. At this point, buy buy buy.

Mr Market

One of the greatest ideas taken away from The Intelligent Investor is that of Mr Market. Mr Market is a useful metaphor for the behaviour of the market.

Mr Market is constantly asking to buy your shares or is attempting to sell you shares at frequently changing prices. Mr Market's mood is constantly changing and often without any real rational.

Don't be overly influenced by the mad market

Fortunately, you only have to trade with Mr Market when you want to. If Mr Market bids a good price for your shares, then by all means sell to him. The important thing is that you are the one in control and you do not let your mood or opinion on the value of your own shares fluctuate based on this irrational person constantly changing their mind on your shares.

You can give as little attention as you please to the price movements in the market.

More than that, you can use these price movements to play the master game of buying low and selling high.

Have the courage and confidence in yourself to make the right decisions independent of what the market is constantly suggesting. If you have formed a conclusion from the facts and if you know your judgement is sound, act on it - even though others may hesitate or differ’ you are neither right - nor wrong because the crowd disagree with you. You are right because your data and reasoning are right.

Finally, let me point out that this blog suggests often for you to think independently which is sort of ironic. But, the point is that the market will often make poor decisions and poor evaluations of a player's value. Use useful resources such as FIC to get more information on players to help you form your overall judgement. But, ultimately make sure that the final decision is yours and formed from logic and not just pure emotion.


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