Every Investor’s Dream
Every investor dreams about finding the next great stock, like a Walmart or a Google. If you are an old school investor like me, you may be thinking about finding a “10-bagger”, as Peter Lynch would call it. Picking just one great stock could change your entire fortune.
Why this Rarely Happens for Most Investors
Why is the average return of an average investor below average? Probably for the same reason the average return of a professional investor is below average. If highly-experienced professional investors can’t beat the market on average, then what are they doing wrong? What are we all doing wrong? Being an average investor myself, I have an opinion about this.
I believe investors are looking backwards into history in order to find something that they hope will happen in the future. They think there must be some kind of magical indicator or algorithm that can help them find the next Google. Many books have been sold with the promise of revealing this secret. But, after hundreds of years and thousands of books, no one has delivered a single indicator capable of determining the future.
Finding the Next Great Stock – By the time a hot stock is featured in the financial news or it shows up in a stock screener, most of the profit has already been made. Then, everyone buys the stock High, bidding it way up past any reasonable valuation. And when the hype and the stock price begin to fade, everyone starts to sell it Low. Finding the next great stock, means you must have the wisdom to identify it and then the courage to purchase it, without validation from anyone else. That’s why everyone talks about the next big stock, but so few actually purchase it.
Catching a Falling Knife – If you aren’t familiar with this investor’s phrase; it means that it’s nearly impossible to tell when the market (or a stock) is going to hit bottom, when it is dropping in a panicky free-fall. And trying to guess at the bottom is like trying to catch a falling knife. You can lose a lot of money in a big hurry. This is one reason buying low is harder than it sounds.
The Sky is the Limit – The hardest thing for me, is trying to figure out when to cash out of a hot stock, when it is headed up like a rocket. How do you know when a stock is over valued, so you can sell it? How do you know if you are selling the next Google at a fraction of it’s future value? This is one reason selling high is a lot harder than it sounds.
Stop & Limit Orders – One strategy I have tried with mixed success is in using Stops and Limits to get in and out of stocks. My Stops kept getting punched out at the worst possible time, for the lowest sell price. What I didn’t realize was that my Stop order was visible to the Floor Traders and they would take advantage of this. Now, I use Hidden or Trailing Stops, so I can protect my position, without exposing my trade.
Dumb Luck & Dollar Cost Averaging
Nothing in my 20+ year investment experience was so disheartening as watching 40% of my portfolio disappear, after the Tech Bubble burst. It didn’t matter that most of this value was from recent gains, it was still devastating to me. I had reached a portfolio milestone that I had sought for many years and now it was quickly gone and headed backwards.
So, there I was. I had lost 40% of my portfolio value, I was laid off from a startup company and I had options on 10,000 shares of worthless stock. For all of the hard work and careful planning, it wasn’t working out too well. The only good news, is that I had plenty of time to think about what had happened, while I was looking for a new job.
I’ve done a lot of dumb things as an investor. But this time, I did something smart. I decided that I had already made the big mistake and I wasn’t going to make another mistake on top of it. So, instead of panicking, I just kept buying more shares every month. This didn’t make up for the total losses from the crash. But, it did allow me to buy Low and enjoy great returns throughout the recovery cycle.
The Bottom Line
The bottom line is that every investor knows they should buy low and sell high, but most can’t pull the trigger when the market is crashing and everyone is running for cover. It’s certainly no easier to take your profits when your stock is in the news and you are feeling pretty smart about yourself. So, consider using Stops, Limits and Dollar Cost Averaging to take the emotion out of your trades.
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
Warren Buffet – The richest man in the world.