CHAPTER 7How to Think About Behavioral Finance
While Benjamin Graham is considered the “father of value investing,” he had a deep appreciation for the impact human emotions can have on stock prices. For instance, in the first edition of Security Analysis, published in 1934, Graham states, “Investment theory should recognize that the merits of an issue reflect themselves in the market price not by any automatic response or mathematical relationship but through the minds and decisions of buyers and sellers.” He also understood the importance of feedback loops, stating “the investors’ mental attitude not only affects the market price but is strongly affected by it.”1
The Moody Mr. Market
In The Intelligent Investor, first published in 1949, Graham introduces his readers to Mr. Market, an affable fellow who is your equal partner in a private business. According to Graham, “Every day he [Mr. Market] tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.”2
Graham used Mr. Market to explain the effect he saw that the human emotions of fear and greed can have on stock prices. When the market is functioning normally, Mr. Market’s ...
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