Everybody has a reason to buy
Talking to people owning stocks, you will realize that most amateurs spend most of their time on the ‘What’ in the stock market – the selection process or justification for buying individual stocks, funds, and so on. These are commonly the stocks they like the most, for whatever reason.
Barring the hopeless gambler that pounces on any stock that moves up using their smartphone brokerage app, the average person in the market actually has done some due diligence on the stocks they’re interested in, based on whatever they believe is the right amount of research to find the right reason to own a stock.
Whether any single “investor“/speculator’s approach has merit or is sufficient is another question, but most people undoubtedly have put in some work on the reasons why they bought a specific set of stocks. It is unfortunate though, that this is often the lion share of what amateurs spend their time on – because stock selection is only one element of success.
When I say ‘amateur’, I refer to those that try to make money in the market not as a profession but as a somewhat haphazard hobby.
There are those that will buy stocks as a long-term ‘investment’, usually because they have fallen in price and are now attractively valued to them.
There are others that will buy a stock out of FOMO, because they hear a lot of furore surrounding it in a roaring market. Many of them will suffer losses quickly, as the hottest stocks du jour tend to be late in their runs. They will blame ‘them’, the insiders, the big boys, and the market makers, for shaking them out, calling it a rigged system.
There is the conservative long-term buy-and-hold investor (at least he thinks he is) who will curse “the speculators” of this world, and obsess about why – in their belief – they drive the markets up and down to cause irrational volatility. A few months later, some of them will gleefully forget about that and start dabbling in the hot stocks of the day in the same way as those they insulted shortly before.
The list goes on, as there are as many hybrid and morphing psyches of market participants working the markets as there are grains of sand on the beach.
And, of course, whatever their starting point, almost all amateur market participants will one way or another over-commit to their pet stocks, get emotionally married to them, and eventually ride them for years through deep 40-80% draw-downs, or more.
Immediacy is the marching order
I cannot possibly go into detail on the large number of fallacies that cause amateurs to do what they do, of which some were tangentially mentioned above.
But the biggest one by far is to be ignorant of the fact that there is a time for everything – a time to get involved, a time to be involved, and a time to cease being involved.
The average person succumbs to the erroneous believe that whatever one intends to do, it should be done there and then. There is something in financial markets that leads amateurs and even many professionals to believe that immediacy in action is the only worthwhile tactic to achieve success.
Of course, from early on society teaches us that inactivity and hesitation can be a problem and lead to missing out in life.
You snooze, you lose.
There’s no time like the present.
The early bird catches the worm.
First come, first served.
Opportunity only knocks once.
A day late and a dollar short.
I’m sure you’ve heard more.
When it comes to buying decisions, the number one factor for most people is finding whatever they believe are the best stocks. This comes with the understanding that buying/trading said stocks should happen as soon as possible – “time is running out, the longer you wait, the less you can make”.
Selecting good stocks is only the start
Contrary to this standpoint, consistent success in the markets is actually predicated on timing as much as the tides are on gravitational pull. The ‘When’ is the single most important consideration, even before the ‘What’.
You may be a self-proclaimed long-term ‘investor’ – if you buy at the wrong time, you may sit through years or decades of lost time or lost money in stocks or mutual funds, and your precious individual stocks might never come back. You might argue that you have the time to wait, but a) why go through a draw-down at all, if it can be avoided, and … b) you might actually not have the time.
You may be buying stocks with the expectation of more timely profits, expecting to cash out in a time span of weeks to months after buying. Here, getting into a stock at the wrong time and holding on to it, or at the right time and riding it, is and always will make the difference between winning and losing in the long run.
Or you may belong to any other denomination of market participant, whether that means arbitrage, trading derivatives, macro-investing, hedging, or anything else. It does not matter.
What I’m trying to say is, regardless of whatever you think is the right way of selecting stocks (or financial instruments in general), given that you are selecting them the way that you do, the actual process of selection becomes somewhat of a default mechanical skill, a partially discretionary and glorified checklist.
The true challenge becomes to assess accurately when the right time is to be acting, and how long to be acting, according to the ever-morphing mosaic that the market is. For anyone in the market, whether that’s for a day or a decade, the timing element is crucial for profitability.
Why timing matters
Because the stock market is stochastic (i.e. operates in odds and probabilities), and the success of a strategy depends on the environment it operates in, things work sometimes and other times they don’t. Consistent success thus becomes all about reading odds accurately. The odds of a stock purchase to become a success is dependent on the right time of the purchase – regarding the stock itself, and the market environment. Getting the best odds is a question of time.
You can be right in your stock picking, but being off in the timing will still not make (or even lose you) money. Let me demonstrate on some simple examples of how timing in a stock makes all the difference. These scenarios all could play out over a span of 4 months, or over 10 years – it does not matter for the purpose of this argument.
A stock might move from $50 to $150, and then fall back to $50 in an ensuing market correction. If someone buys the stock for a (to them) ‘good’ reason at $50 but fails to sell near the top and holds the stock back to $50, she has not been successful, because the timing of her exit was faulty. She clang to her reasons, and disregarded the timing element. If her friend buys the same stock for the exact same ‘good’ reason at $150, he has not been successful either by holding it down to $50 – rather, the opposite. If another person buys the stock for a completely different reason at $70 and sells it at $140, she is the only one to have been successful.
In another scenario, a stock that had previously been trading at $80 is now bought at $50 for a ‘good’ reason. But the stock is in a downtrend, and continues to be. The buyers loses his shirt after a year when the stock hits $10.
In yet another situation, a stock is bought at $40. The buyer believes the stock to be ‘great’ (his reason), but the stock continues to go sideways for a long time. In disgust, the owner sells the stock after 2 years, looking on in envy as other stocks that he ignored could have made him good money during that time. One month later, his friend buys the same stock at $40 for the same ‘great’ reason, and it soon begins to rally to $120 over the next year. She sells it for a profit. The earlier disgruntled seller has now again become interested in the stock, buys it for the same old ‘great’ reason at $120 … and it drops back to $60 in a market correction.
Whether the reasons of all these people were right or wrong to buy their stock, only few of them made money on their transactions – the ones with the right reason and right timing. This is to demonstrate the simple but crucial importance of the timing element of stock purchases, versus the reasons for stock selection. You can do everything right, but be there at the wrong time, make a commitment at a time of bad odds, and you’ll still lose.
Of course, there are a couple of problematic beliefs and fallacies being uttered by long-term ‘investors’ regarding their timing the moment their speculations turns against them, which I’ve dispelled previously.
Look at odds, risk and reward
Above I mentioned ‘best odds’. You need to define for yourself what that means in the context of your strategy. In abstract, this boils down to identifying inflection points where the reward outweighs the risk that you have to take by a wide margin (at a bare minimum, 2:1, but better 5:1 or 10:1 or higher), and restricting market operations to times where the market is conducive and your chances of realizing that expected reward in reality are optimal.
This all highly depends on your specific strategy.
For example, purely technical short-term traders need to fully grasp the statistics behind trading to be profitable (e.g. check out Ralph Vince’s classic “The Mathematics of Money Management: Risk Analysis Techniques for Traders”). But pure focus on risk/reward ratios still can and will wreck the accounts of many from over-trading, if they do not understand how to assess whether a market is conducive to their expected reward actually manifesting.
The larger the expected reward becomes, the more it is crucial to be able to spot, as I wrote above, windows of time when your chances of realizing said reward are optimal (or not). Everyone focuses on chart reading and stock-picking all the time, but few people really look at the health of the market to influence their decision-making. This is for example pertinent to stock speculators trying to benefit from multi-week or -month moves in stocks. If someone likes that tries to continuously start positions in a choppy range-bound market, he will grind his account balance down slowly but steadily.
You need to ask yourself, how high is the chance of your expectations coming true? How high are the chances of the market supporting your strategy? But as Victor Sperandeo comments, the most important question is always “Can I make money”? Have you been able to observe in the market that your strategy is gaining traction and is producing results over a recent window of time? Have you been able to capitalize on that? If yes, you should try to increase your activity, if not, you should do less of what you’re doing, or nothing. Doing more of something that doesn’t work won’t get you ahead. In fact, it will do the opposite.
It’s different again for longer-term holders that try to establish a ‘foothold’ positioning in the market after a major correction or bear market. Risk management is a foreign thought to most ‘buy & hold investors’, but ignoring reality will not protect from it. Of course, no serious market participant should ever ignore risk – it always comes first and last. Anyone buying and holding for the long term should have some strategy of knowing the odds of her chances of making money the moment they enter the market. Correct assessment of odds, current position in the market cycle, and market health analysis is equally crucial. Consider reading Gerald Loeb’s 1935 book “Battle For Investment Survival”. It’s a great starting point for the uninitiated, and will save you a fortune in losses stemming from ignorance. And please forget about valuations. There is no point in buying into market tops or a continuing bear market downtrend, losing a substantial part of your capital, and whenever stocks start trending up again to claim that now you’re making money – you’re digging out of a whole instead, and waiting for higher odds would have given you a massive head start.
It’s difficult to get into detail here, because everything hinges on your strategy and your time frame. The point I’m trying to get across is that whatever you want to do, you need to take things seriously, and understand timing and odds. It’s paramount for your success in the market that you develop a method of stock selection, and hone it. But it’s even more critical that once you’re able to make good selections, you actually spend the majority of your time and effort in seeking the right timing for a commitment. There are better or worse ways to select stocks, of course. But even so, there is a bigger facet to the diamond of successfully profiting from stocks – awaiting the right moment, patience. Get in sync with the market, and the stocks in it.
For those traders and speculators interested in an integrated way of learning necessary concepts, tactics and factors to asses the right timing of entry-, exit points and the market environment, check out my stock speculation bundle. Why not start off on the right foot?
