Mr. Market is a metaphor that represents moody behavior of stock market fluctuation.
Scenario 1: It's early morning and weather is gloomy. Mr. Market woke up with great pessimism. He is about to deliver bad news to investors by offering low stock prices.
Scenario 2: It is summer time and Mr. Market is looking forward to enjoying the sunshine. He is going to the beach after the stock market closes. Since he is optimistic about his day, he will be delivering good news by offering high stock prices.
Mr. Market is a mental model on how to view the market behavior. Mr. Market is a fictional character who is driven by many emotions and mood on any given day rather than through rational analysis. Mr. Market should only be taken seriously when prices presented are favorable to you.
Mr. Market is a fictional character created by investor and professor Benjamin Graham to describe irrational behavior of stock market. He explained Mr. Market as a daily visitor knocking on your door offering stock prices that you can buy or sell at. You can either transact with Mr. Market or ignore him.
Graham introduced Mr. Market in Chapter 8 of his classic book The Intelligent Investor.
Graham explained the unstable character of Mr. Market who wakes up happy one day, and sad the other day. He further explains the job of an investor is to take advantage of him on the days when he is in bad mood offering depressed prices.
In the short run, the market is a voting machine but in the long run, it is a weighing machine. — Benjamin Graham
Benjamin Graham was also Warren Buffett's intellectual father.
If you understand chapters 8 and 20 of The Intelligent Investor (Benjamin Graham, 1949) and chapter 12 of the General Theory (John Maynard Keynes, 1936), you don’t need to read anything else and you can turn off your TV. — Warren Buffett
Imagine if you own a local grocery store and if Mr. Market showed up everyday with different prices on what your business is worth. You would most likely ignore him and focus on serving your customers. You will have a better idea on how your business is performing based on your financial reports. But Mr. Market does not care about your insights! Mr. Market is that annoying neighbor who does not care if you are interested. He will show up everyday whether you like him or not.
The wisdom to ignore Mr. Market is hard to put in practice because it requires a lot of patience. Benjamin Graham wrote the following passage in Chapter 7 of The Intelligent Investor:
The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgment.
Jason Zweig is a Wall Street Journal columnist who has been revising The Intelligent Investor to keep up with times has commented on the passage above:
This may well be the single most important paragraph in Benjamin Graham’s entire book. In these 113 words Graham sums up his lifetime of experience. You cannot read these words too often; they are like Kryptonite for bear markets. If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.
Warren Buffett explains further on Mr. Market in his 1987 Berkshire Hathaway shareholder letter:
Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his. Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him. Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy...In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.
Charlie Munger on Mr. Market:
Of course, the best part of [Benjamin Graham's approach] was his concept of "Mr. Market". Instead of thinking the market was efficient, Graham treated it as a manic-depressive who comes by every day. And some days "Mr. Market" says, "I'll sell you some of my interest for way less than you think is worth." And other days, he comes by and says "I'll buy your interest at a price that's way higher than what you think it's worth." And you get the option of deciding whether you want to buy more, sell part of what you already have, or do nothing at all. To Graham, it was a blessing to be in a business with a manic-depressive who gave you this series of options all the time. That was a very significant mental construct. And it's been very useful to Buffett, for instance, over his whole adult lifetime.
Seth Klarman, another legendary investor on Mr. Market:
An ever helpful fellow, Mr. Market stands ready every business day to buy or sell a vast array of securities in virtually limitless quantities at prices that he sets. He provides this valuable service free of charge. Sometimes Mr. Market sets prices at levels where you would neither want to buy nor sell. Frequently, however, he becomes irrational. Sometimes he is optimistic and will pay far more than securities are worth. Other times he is pessimistic, offering to sell securities for considerably less than underlying value. Value investors – who buy at a discount from underlying value – are in a position to take advantage of Mr. Market’s irrationality. Some investors – really speculators – mistakenly look to Mr. Market for investment guidance. They observe him setting a lower price for a security and, unmindful of his irrationality, rush to sell their holdings, ignoring their own assessment of underlying value. Other times they see him raising prices and, trusting his lead, buy in at the higher figure as if he knew more than they. The reality is that Mr. Market knows nothing, being the product of the collective action of thousands of buyers and sellers who themselves are not always motivated by investment fundamentals. Emotional investors and speculators inevitably lose money; investors who take advantage of Mr. Market’s periodic irrationality, by contrast, have a good chance of enjoying long-term success. Mr. Market’s daily fluctuations may seem to provide feedback for investors’ recent decisions. For a recent purchase decision rising prices provide positive reinforcement; falling prices, negative reinforcement. If you buy a stock that subsequently rises in price, it is easy to allow the positive feedback provided by Mr. Market to influence your judgment. You may start to believe that the security is worth more than you previously thought and refrain from selling, effectively placing the judgment of Mr. Market above your own. You may even decide to buy more shares of this stock, anticipating Mr. Market’s future movements. As long as the price appears to be rising, you may choose to hold, perhaps even ignoring deteriorating business fundamentals or a diminution in underlying value. Similarly, when the price of a stock declines after its initial purchase, most investors, somewhat naturally, become concerned. They start to worry that Mr. Market may know more than they do or that their original assessment was in error. It is easy to panic and sell at just the wrong time. Yet if the security were truly a bargain when it was purchased, the rational course of action would be to take advantage of this even better bargain and buy more. The fact that a stock price rises does not ensure that the underlying business is doing well or that the price increase is justified by a corresponding increase in underlying value. Likewise, a price fall in and of itself does not necessarily reflect adverse business developments or value deterioration. It is vitally important for investors to distinguish stock price fluctuations from underlying business reality. If the general tendency is for buying to beget more buying and selling to precipitate more selling, investors must fight the tendency to capitulate to market forces. You cannot ignore the market – ignoring a source of investment opportunities would obviously be a mistake – but you must think for yourself and not allow the market to direct you. Value in relation to price, not price alone, must determine your investment decisions.
To deal with Mr. Market, you need a right temperament and virtues because market is unpredictable but your behavior is not. Great investment returns lie in doing nothing, but we all deal with do-something-syndrome. Let Mr. Market serve you, not guide you! Take advantage of prices when they are attractive to you!