A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Thursday, August 9, 2007

OMG! The stock market can go DOWN!?!?!?! - A little advice from an investment pro

A good stock chart can tell a great story... as does the chart below depicting the S&P 500 over the last year.

Click on the chart for a larger image.

Apart from being a great reminder that the market is really just a bunch of scared, greedy people buying and selling... this chart is a prime example of why most small-time investors (as I presume you are) underperform the pros by a significant margin. We all want to buy after we've seen "YAY!" for a while (for fear of missing out) and sell immediately in times of trouble (usually a few days after a big drop, when we don't see a rebound).

Guess what? The guys who make the real money in the markets do the opposite. They buy when you soil your pants and give your shares away at bargain basement prices, and they sell to you when you want to jump on the bandwagon.

This is why I'm buying now, as I did in early March. Lot's of good stocks fall for no reason other than blind fear. The key is separating the wheat from the chaff.

Oh, and remember... there is a difference between price and value... every stock has one value, but many prices.

3 comments:

dxm113 said...

I agree with what you are saying, as far as many small-time investors buying and selling at the wrong time. Your point is well taken. Good point about price vs. value (Benjamin Graham would be proud).

However, I also think that many small-time investors won't beat the professionals because of time constraints.

I might not ever beat the professionals, but I believe that I could do much better (than I currently am) in the stock market if I had more than a few hours a week to keep and eye on my investments.

dxm113 said...

Eternitus,

Jim Cramer recently made a statement on his show that the traditional "buy and hold" strategy no longer is effective in today's markets. It seemed that he was alluding to a "buy low / sell high short term strategy" but not necessarily day trading. While I don't take his word for gospel, it was an interesting statement.

What's your take on this? Should I have sold while Wall Street was so bullish, and repurchased at lower price after the credit woes hit? Would taxes have negated most of my gains (both short term and long term capital gains)? Was Cramer just putting a spin on trying to time the market?

I have most of my money tied up in good, low cost, mutual funds - both in my 401k and personal IRA. However, I'm trying to learn how to play the game with a little side money...

Thanks in advance!

eternitus said...

DXM... you have to watch the markets closely and get a feel for them (in individual stocks / sectors) to employ that strategy - you need a lot of time at work to look at your stocks trade, and you have to figure out which ones are gyrating for a reason, and which are just falling for no reason (people will come back to these, while they won't for the former).

And, you should be forewarned, such strategies suck you in like a black hole.

Another thing is trading costs... if you really want to be a trader, I'd recommend you get a direct access broker like Interactive Brokers Group... you can execute trades there for as little as $1.00, but you have to be experienced. If you're paying $10.00 a trade, and you're trading $500 blocks, you need to clear a 4% gain just to break even.

In very volatile stocks, it can be a very effective tool (I have been using it for shipping companies (EXM, DSX) - you buy on obscene dips (like when I quadrupled my position on a 15% decline yesterday) and sold my new shares on the rebound spike (22% above my entry point).

It takes courage(I always feel fear when I double-down on a big loss) and a little bit of luck... but I was lucky enough to get a 22% one-day gain off of that trade (I've been not so lucky other times).

But, I have been watching this stock for months... I just knew that a 15% decline was too steep for such a quality company in a great sector... It had to be an overleveraged hedgie dumping his winning shares to satisfy margin calls in the panic... and I was able to benefit handsomely.

Cramer was talking about a buy-and-hold strategy for individual stocks, and I tend to agree with him in volatile markets, given the short-term market distorting power of hedge funds. Unless you find a company that you really love, and are sure will outperform the market over the next few years, you shouldn't buy and hold many individual stocks (I hold only 10 - 15 in my portfolio right now, the rest are razor-thin-fee ETFs).

However, he's not telling you not to buy and hold stocks as an asset class (which has generated 10% compounded annual returns historically - just check the "entire history" charts of the DJIA on Yahoo! Finance). If you don't have time to research and follow stocks daily, the best way to get those strong market returns with minimal volatility and effort is to buy a low-cost, broadly diversified mutual fund.