Howard Marks says superior returns come from reading investor psychology. Here are his 'most essential' tips for doing that

• Studying investor psychology can help secure better returns, Howard Marks wrote in the Financial Times.
• Emotions are often behind large swings, and can act as a signal for market movement.
• "Remember that in extreme times, the secret to making money lies in contrarianism, not conformity."

Investors who consider the psychological momentum behind large swings can often secure higher returns, Howard Marks wrote for The Financial Times. 

The co-founder of Oaktree Capital Management offered tips on how to take the "temperature of the market" and read investor psychology.

"Everyone can study economics, finance and accounting and learn how the markets are supposed to work. But superior investment results come from exploiting the differences between how things are supposed to work and how they actually do in the real world," the billionaire investor wrote.

Here are the "most essential" components on how to do that, as he laid out in FT:

Recognize market patterns

Marks encourages investors to study market history to better understand current events.

"Ironically, investor psychology and market cycles — which both seem flighty and unpredictable in the short term — fluctuate in ways that have more for regular patterns when viewed over the long term," he said, though the the casualties, timing, and amplitudes may still vary.

Understand cycles

Instead of seeing market cycles as a series of ups and downs, Marks views them as a series of events. For that reason, investors should look at cycles as a constant shift between excess and moderation.

"Thus, a strong movement in one direction is more likely to be followed by a correction in the opposite direction than by a trend that 'grows to the sky.'"  

Look out for the emotional highs and lows

The idea that a stock can endlessly gain is a key signal to look out for, as limitless optimism may indicate a price level's growing unsustainability. Similarly, shareholders who demonstrate excessive cynicism will most likely be willing to sell stock at any price, Marks wrote.

In extreme times

"Remember that in extreme times, the secret to making money lies in contrarianism, not conformity. When emotional investors take an extreme view of an asset's future and, as a result, take the price to unjustified levels, the 'easy money' is usually made by doing the opposite."

But that doesn't mean going against the consensus all the time, he cautioned. To succeed at contrarianism, investors must understand what the herd is doing and why, what's wrong with that stance, and what to do instead, he explained.

Marks concluded by noting that much of what happens in markets isn't the result of "a mechanical process," but swings in emotions that can be exploited. He also urged investors to resist their own emotional swings while being wary of "illogical propositions."

"When you come across a widely accepted proposition that does not make sense or one you find too good to be true (or too bad to be true), take appropriate action."