Psychology

Don't Buy High & Sell Low

People want to buy a winning stock, so they buy a stock or mutual fund that's doing well. Then it goes down, so they sell it. They're buying high and selling low, the opposite of what you're supposed to do, and that's why it's easy to lose money in the stock market if you don't invest with a plan. Make a good plan and stick to it, considering appropriate entry and exit strategies, and if you avoid panic selling, you're likely to make money instead of losing it. The market always goes up if you invest long-term.

When a stock has been doing well, it could now be overpriced, which is not always a good time to buy. And when a stock is down, it isn't the best time to sell. It isn't possible to always sell at the peak and buy at the trough, but we should at least try not to buy at the peak and sell at the trough.

Knowing this, we can become too reluctant to sell a losing stock. Maybe you don't want to sell a losing stock until it goes back up to some arbitrary price so it feels like less of a loss, thus the money sits there earning nothing. If you can earn more by putting the money into another investment, you should sell quickly. If a bad investment is going to recover at a rate of 3% while some other investment will grow at 8%, then you're losing even more money by being unwilling to sell the loser investment at a loss.

Instead of worrying too much about timing, use dollar-cost averaging to reduce the worry a little.

Watch the Round Numbers

When a stock price is spending more time above a nice round, even number than below, it indicates strength. When the price of a stock dips below a psychologically important threshold like 100, if most people are thinking it's a good time for buying, the price will not stay below 100 for long at all.

If the stock is spending most of its time below an important threshold, it indicates weakness. So people see the price go over 100, and most of them choose to sell immediately, so the price doesn't stay over 100 long.

You can expect a price to bounce around as it crosses a psychologically important number as those who want to buy or sell at that threshold do so, after which they lose further influence on the price. Smart day traders might try to capitalize on those bounces.

So imagine you have a strong stock that climbs fast, maybe 30%, and reaches over $500 per share. At this psychologically important number, many investors choose to sell to lock in their gains, so the price dips back down a few dollars. Some other investors see the dip and wish they had sold when it still was over $500.

But other investors continue to jump onboard because it's a strong business, gradually pushing the price higher. The ones who were itching to sell above $500 earlier have their second chance, and now there are fewer people left who want to sell above $500, mostly only buyers, so the price continues to climb onward to the next psychologically significant situation, a price or maybe a chart shape. But some genius day trader made a lot of money from those bounces.

Self-fulfilling Prophecies

Some strategies might have become self-fulfilling prophecies. Investors who believe that a head-and-shoulders pattern indicates a pending downturn will all sell upon seeing it, thereby causing the price to go down. They expected a downturn, so they sold and caused the downturn or started a trend that caused the downturn.

Competition versus Cooperation

Investing in the stock market is in some ways competitive and in some ways cooperative. It's competitive because investors are competing for the same dollars. I think we all want to make more money than everyone else in the stock market. It's cooperative because when you buy a stock, you want others to buy it as well so its price will rise. And we're all cooperating when we invest in businesses that improve our lives.

Do the Opposite of Everyone Else?

Some say that in order to make money in the stock market, you should do the opposite of what everyone else is doing, but that doesn't always seem like a great plan. Instead, you should do what other people will do before they do it. What you want to do is to buy before everyone else buys, then sell before everyone else sells. That might sometimes mean doing the opposite of what everyone else is currently doing, but not always.

Knowing what everyone else will be doing in the future is the hard part. We can only make an educated guess based on the information that we are able to gather.

Get an Edge

Every advantage helps when you're trying to beat the market. Every tenth of a percent matters. To try to give yourself more of an advantage, you might attempt your own kind of insider trading. For example, if you have influence, you could try to use it to affect the market. You might write a positive article about a stock in hopes of causing its price to rise after you buy shares, or write a negative article about a stock after you short. It can't hurt, and it might even help. Actual insider trading is often illegal, but I think it's safe to write an article.

And if you make a purchase of a stock, let it be known so maybe a chain reaction will develop to drive the price up. There is no benefit in keeping the purchase secret unless you intend to buy more, but there is a benefit in announcing it. If you're worried other investors will steal your profits, you're not thinking things through. If other investors buy the stock, it will only drive the price up, which helps you as a stockholder.

Simply telling everyone that you bought a particular stock is like a gleaming personal endorsement and might influence other people to buy it too, driving its price higher. You might have more effect on an unpopular stock.

This page is intended as educational and informative and is not to be taken as personalized financial advice. Strong efforts are made to ensure these documents are correct, but there could be mistakes, especially when first uploaded. Please verify important facts before making investing decisions.