Got this email this morning from StockScores.com . Has some good reading for a slow weekend.....Have a great holiday everyone!!!
The stock market is a money machine for a small number of people. Most investors, including mutual fund managers in nice suits, don't beat the stock market. You should accept this fact if you are investing in stocks.
That does not mean there are not lots of people who are making money in stocks. The problem is that they are only doing it from time to time. There are few who consistently do it, the rest are just getting short term loans when they hit a winner. Eventually, most investors give back their gains.
The result is that the average investor, whether they are making their own investment decisions or letting someone else do it for them, is earning what the market earns over the long term. Historically, that is about 7% per year.
Who is making all the money?
For the most part, it is the insiders. The people who start the companies that are the basis for the paper the financial industry calls stock certificates. The game is simple; sell the paper to the investing public, make a lot of loot, buy big houses in Florida.
Admittedly, my cynicism is over the top, but you get the idea. The stock market favors a small group of people who know more than the rest of us. For a long time, I have been telling people that to do well in the stock market, you have to do what the insiders do, but I have come to realize that doing this alone is not enough.
My preaching over the past ten years has focused on using market activity to figure out what the smart money is doing, and then do the same thing. One step behind the smart money, but 10 steps ahead of the public, and most anyone with access to stock charts can do well in the market. I made a lot of money trading stocks because I focused on the stock that are behaving abnormally and traded them well using simple technical analysis.
However, there is more to the game of trading stocks than just good analysis. There are good chart readers and well informed insiders that have the same thing in common; they can not make money in the stock market. Their lack of performance shared the same reason.
They don't have their head screwed on straight.
Actually, they do have their mental faculties properly aligned, but they are just not set up properly for stock market trading. From the time we are small children we are taught to avoid pain and seek out pleasure. We can all hear our parents warning us to not touch the stove, but to have a good time when we joined our friends. Our upbringing is destructive to our performance in the market. To be successful, we must learn to be behavioral deviants.
To make my point, I outline the life cycle of a stock, and how the successful trader differs from the minion who has the typical psychological responses to the stock market;
Stage 1 - Accumulation. Stock is quiet, trading sideways and without a lot of volatility. Most everyone ignores the stock because it has no sizzle. Insiders hold large blocks of stock and quietly gear up for the distribution.
Stage 2 - Breakout. Volume jumps up, psychological barriers are broken. Insiders begin to tell their friends of upcoming significant fundamental change. Pros take notice and buy the stock on the coat tails of the well informed. The public ignores it because they have not read about the company in the paper yet. It must be a scam.
Stage 3 - Uptrend. As a larger audience learns of the company and its promise, more buying comes in to the stock and it begins to climb. Pros begin to sell, but slowly. Average investor begins to buy.
Stage 4 - Pullback. The stock has gone up too fast, and some profit taking arrives. The jumpy investor who got the entry timing right but lacks confidence in his or her decision sells the stock with a small profit, and smiles in the mirror. The Pro holds on, Average Investor looks through the newspaper to find justification for ownership of the shares.
Stage 5 - Resumption of the Uptrend. The pull back is short lived, and the stock bounces and continues higher. The wannabe regrets the sell, but provides self counsel on the merit of making a profit, albeit a small one. The Pro might sell a little bit more, but still holds the majority of the original position. The Average Investor is getting excited now, and thinks about what could have been if only he had bought when he first noticed the stock.
Stage 6 - Exhaustion of the Uptrend. The media takes notice, and communicates the company's merits to the masses. The masses buy the stock, and it goes up sharply with strong volume. The Pros sell with enthusiasm. The Average Investor owns it now, and is telling everyone who will listen. The wannabe Pro jumps back on, after all, he was smart enough to buy it when the trend started, so he knows the stock well. Will hope make it go higher?
Stage 7 - Gravity Works. Pro selling begins to weigh on the uptrend, and the stock fails to go higher despite high volumes. The stock starts to go down instead of up, and the Pro is almost sold out. The Average Investor continues to cheer lead, hoping to rally support. The wannabe ignores what the market is telling him, taking a loss is too painful to consider. The company is featured on the cover of a magazine.
Stage 8 - The Second Guess. The stock bounces and starts to go back up. The wannabe Pro averages down while the Average Investor gets back to advising friends of his stock picking acumen. Pros sell their remaining holdings and begin to look for another deal to play, or perhaps start short selling the stock.
Stage 9 - Out of Gas. The bounce is a fake out, and the stock moves lower again. The public own this stock, and they have no more power to buy. The Pro are making money on the short sales now, but are despised by the masses. Calls for short selling to be made illegal are made by the Average Investor, after all, the short sellers are the demons causing the sell off.
Stage 10 - Dead Cat Bounce. The Average Investor and the wannabe Pro have no pain tolerance left, and finally sell for a big loss. The short selling Pros are the only buyers to take the share off their hands, and provide the needed liquidity. The stock bounces, and some short term traders make a quick profit. The Average Investor either swears to never buy a stock again, or tells lively stories over drinks about the one that could have been.
Stage 11 - Post Mortem. Pros have forgot about the stock and are considering carpet samples for their new home in Florida. Average Investor continues to follow the company and buys loads of cheap stock to try and overcome the regrettable loss.
The stock market is mean. You can be a good analyst, but if you can't overcome the psychological traps of trading, you will do what the crowd does. To be successful, you have be one step ahead of the crowd, and trade with unemotional discipline. There are strategies to take advantage of each stage of the market cycle that can be applied just by looking at a stock chart. They just require a bit of knowledge.