4 Ugly Things Investors Don't Know About Stocks
by Peter Leeds
Read all the past Blog entries here
There are 4 ugly truths about the stock market that you, along with most investors, probably do not know. Hopefully this doesn't freak you out too bad, but the good news is that you will become a better stock market trader for it! And instantly!!
1 - Majority of investors lose money
Yes, it's sad, but it's true! Basically, when the crowd stampedes in one direction, the boat tips, and everyone drowns.
If there were 100 people on a life raft, but only room for 97 to
survive, the crowd would jostle for position, frantically clamoring over
one another to get a safer spot. A lot more than 3 people would end
up drowning. This is what humans are like, whether on a life boat, or
Yes, lots of investors trade too frequently, buy the wrong shares, or make irrational decisions based on impatience, fear, greed... It is easy to understand why this type of person losses money when trading.
However, the entire stock market structure means that most people need to, and will, lose. The masses are chasing a swinging pendulum - and they over-pursue right up until the point where it changes direction and swings the other way. Investors can only look on as the pendulum moves back towards where they were standing in the first place!
Invariably, the mob then starts running after the swinging pendulum again, forgetting that it will be coming back to where they are standing right now!
Tip: Do the Majority Really Lose Money?
Yes, but it depends on the time frame, the segment of investors you look into, even the stock market behavior at the time. It is possible to show time periods where certain groups of investors made money. It is also possible to show the exact opposite.
Long term, the crowd loses. More people lost money by piling into the dot com bubble, pot stocks, or even automobile manufacturers (there used to be 1,800 in the year 1910, now there are 3) than the number of people who posted a profit.
2 - Sentiment is contrarian indicator
Investor sentiment refers to how people feel about the stock market. For example, if 70% think stocks will go up, that's mildly positive investor sentiment. If 90% are expecting a crash, that's significantly negative sentiment.
Pretty straight-forward, sure. However, here's the angle where you can profit a lot, and for the rest of your life. Sentiment is a contrarian indicator. That means the market typically performs opposite to what most people expect.
It works like this - the more people who think stocks will move higher, the more who have positioned themselves to benefit from it. In other words, they've bought shares.
This lifts shares even higher, reinforcing their "I told you so" attitude. Others on the sidelines see the gains, and they pile in as well. This continues the lift toward higher prices.
There comes a point where sentiment has reached such optimistic levels that there is no one left to buy. All the people who think shares are moving higher have put their money "on the table" so to speak. There is no more buying left.
After the long, sustained uptrend, there eventually will be some profit-takers... and they sell their shares into what is almost non-existent demand. Prices reverse lower, sometimes very strongly.
The same mentality works, in reverse, for negative investor sentiment. If more that 90% of people believe the market is going to crash, then I'm typically a buyer.
Tip: Buy the Rumor, Sell the Fact
This is why a company comes out with grand slam earnings, and the shares go down!? A biotech gets the FDA approval they needed, and the stock dumps to lower prices?!
Everyone expected the positive results (the 'rumor'). Everyone bought already, waiting for the great news to spike the shares. Upon it's release (the 'fact'), there were no buyers. Even a little bit of selling now can collapse the shares.
3 - The pro's do NOT outperform the index
They'll tell you they have the best strategy, they'll talk like they know more than anyone else, but in the end, the majority of professional traders, hedge fund managers, and mutual fund experts do not outperform a simple buy and hold strategy, or the market indexes.
In fact, this has been the case for decades, and that truth hasn't frightened anyone away from following these under-performing "gurus."
Keep in mind, however, that big-time money managers have a disadvantage. Specifically, it is a lot easier to make 25% on a few thousand dollars, than it is to make 25% on a few billion! Read our recent comments about the 12 Advantages for Investors with Less Than $5,000.
There have been numerous examples to prove our point, everything from third-graders selecting a portfolio of stocks which trumped the returns of the experts, to seeming prescient chickens picking seeds off the NYSE listings.
According to "Gains, Pains, & Capital," only 10% of mutual funds beat the market averages in most years.
"A Random Walk Down Wall Street" was a wonderful book in which Burton Malkiel argues that a blindfolded monkey throwing darts at a newspaper could select a portfolio that would do as well, or better than, one selected by experts.
Read the book, then cry about all the management fees you've wasted over the last decade!
Tip: Blindfolded Monkey
Keep in mind, it wouldn't have to be a blindfolded monkey to make the point. It could be a blindfolded camel, blindfolded honey badger, or blindfolded donkey. Hell, it could even be a blindfolded walrus! (Assuming you have access to a walrus, and can get it to keep the blindfold on!)
4 - Commodity prices are not based on supply or demand
Ever wonder why a 1% supply cut in oil shoots oil prices 65% higher? If demand increases 5%, why do prices double, or even in some cases fall?
Oil prices are controlled by speculation, which is driven by oil traders in London and Manhattan who have never seen an actual barrel of oil in their life.
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