Psst! Want to lose a lot of money?
While there are no foolproof ways to accurately predict the market, there are several foolish ways in which investors can successfully subvert their portfolios and reap big losses. Here are several examples of how unknowing investors can unwittingly sabotage an investment portfolio.
Neglect the Driving Force Behind Any Business: Supply and Demand
Business success (or lack thereof) boils down to two simple words — Supply and Demand. It’s that simple. It doesn’t matter whether you are talking about the oil market, iPods, golf courses, lemonade stands, or the stock market. Simply put, if there are more buyers in a particular security than there are sellers willing to sell, the price will rise. Conversely, if there are more sellers in a particular security than there are buyers willing to buy, then the price will decline. If buying and selling are equal, the price will remain the same. This is the irrefutable law of supply and demand. The same reasons that cause price fluctuations in produce such as potatoes, corn and asparagus cause price fluctuations on Wall Street. The “Point & Figure” methodology I use is just a logical, sensible organized way of recording that supply and demand relationship. It simply arranges the information in a way that makes sense to me. A telephone number is no different; it is just a way of organizing 10 digits in a way that makes sense to us and the AT&T network. A Point & Figure chart is just a way of organizing a series of prices into a pattern that makes more sense.
Attempting to Play the Game Without Knowing What Team is on the Field
Think about your favorite football team for a moment. If they play offense 100 percent of the time, they are going to be marginal at best and at times downright awful. There’s a time to have the offensive team on the field and a time to have the defensive team on the field. The problem with most investors is they don’t know what stadium the game is being played in much less which team has the ball. Before deciding on any strategy, you must know whether you’re in a wealth accumulation mode or a wealth preservation mode.
Arrogance. The Market is Easy to Figure Out — But Only if You Listen
The market teaches humility. The sooner you acknowledge the fact the market is going to do what it’s going to do, and forget about trying to tell the market why it must do something because the economic numbers came out a certain way, the better off you’ll be. A quick look at the sector bell curve from different time periods can provide you a clear picture of what the risk in the overall market is. In October 2011 the world was facing down a financial crisis in Europe, Occupy Wall Street protesters, and a war in Libya, none of which were positive indicators. It was a hard time to invest, but if you stopped coming up with reasons why the market shouldn’t do this or shouldn’t do that long enough, you could have heard clearly what the market was telling you. It was saying risk was low and money should be put to work. Case in point: The S&P 500 gained more than 17 percent from October 10, 2011 through March 29, 2012.
Making Stock Selection Decisions on Fundamentals Alone
General Electric (GE) is a company that has their hands into everything, from industrial manufacturing, aircraft engines, nuclear power, loans (GE Capital), land management/acquisition, and more. GE basically has a hand in the honeypot of pretty much everything you can dream of. For a while, the stock price tracked the earnings in a general sense, but then in the year 2000 that correlation ended. The earnings continued to head higher, and meanwhile the stock price was cut in half. As of this writing, GE is still more than 65 percent below its high, while earnings have more than doubled.
Buying a Stock Simply Because It is a Good “Value”
There are two problems with buying on value alone. First, the stock can remain a great value and not move. Second, the stock can become an even better value by continuing to move lower. I believe it’s great to buy value stocks, but only when demand starts to come back to the stock. The pharmaceutical companies Eli Lilly (LLY) and Bristol Myers Squibb (BMY) are stocks that many regarded as good value investments before their sheer sell-offs in 2000. They have become even better “values” as they have continued their downward decline.
Being Afraid to Buy Strong Stocks
Sir Isaac Newton said, “Things in motion tend to stay in motion.” There’s an old stock market cliché that says the first stocks to double in a bull market usually double again. This mentality would have kept you out of Apple (APPL), which was up 201 percent between January 2009 and August 2010, and rose another 137 percent by the end of March 2012. It also would have kept you out of W.R. Grace (GRA), which was up 201 percent between January 2009 and August 2010, and up another 137 percent by March 2012. These are only two examples, but there are many others.
More important than how much the stock is up is its supply and demand relationship. By assessing the Point and Figure chart, you can gain insight into this relationship to gauge whether or not the stock is likely to move higher. Stocks that double can easily double again. Don’t miss out on these great opportunities.
Selling a Stock Because It’s Gone Up
Have you ever sold a stock for a small profit only to watch it continue to move higher and higher? It’s upsetting for any of us to remember those piles of money we let get away, but we have to keep in mind that in the long run it’s the size of your winners that counts, not how many winners you can find. For that reason, you want to become very judicious at managing the position. When you have a stock with strong technical qualities, prune the position, but hold the core position. There are a number of strategies to retain the core position, from just holding the stock, to using the options market. Relative Strength is one of the strategies I use. It’s a great tool for keeping at least one leg in a position for long-term growth.
Holding on to Losing Stocks and Hoping They Come Back
Often referred to as “buy and hope” or letting your losses run, many people are still holding stocks from the go-go years that have no possible chance of ever regaining their stardom. Just as the size of your winners matters, the size of your losers counts just as much or more. You need to make sure that you always come back with the ability to play another day. If you have a stock that declines 50 percent, then you’ve backed yourself into a corner because now you need that stock to double just to get back to even. It’s a fourth-down-and-forever situation, which is not desirable for any coach.
For example, the person who bought Cisco Systems (CSCO) at $82 in 2000 is reeling from its current price of about $20. That stock would have to quadruple just to get back to even! If you remember the early 2000s, investors were not beginning to sell stocks, this is when the average investor had just gone on margin to buy more. Will energy and gold become the next technology bubble? I don’t know. What I do know is the charts will give us sell points along the way and keep us from holding positions into the abyss.
Making Moves Based on a Magazine Cover
Following the hot news that appears on a magazine cover or a TV show is a shortcut to the poor house. Why would you follow the advice of an editor who has just moved from the society pages to the business section?
For instance, in October 2004 The Economist came out with a cover that said, “Scares Ahead for the World Economy” which would have made you think investing globally was not the correct play. Instead the International Markets’ returns dwarfed the U.S. from 2004 until late 2011. Their October 15th cover headlined, “Nowhere to hide. Investors have had a dreadful time in the recent past. The immediate future looks pretty rotten, too.” Since the then the S&P has gained 15 percent through the end of March 2012.
By staying far away from these money-draining traps, adhering to your pre-determined objectives, incorporating reasonable thought processes and using sound judgment, you can easily safeguard your investment portfolio and eliminate self-imposed losses.
