Due to dynamics grounded in crowd psychology (which we will look at later), and as discussed before, the market’s movements consist of different smaller moves on different timescales, embedded in a larger trend and interrupted by corrections turning points. There are the short-term moves, lasting a few days to to about two weeks, the intermediate-term moves, lasting from 2 to 4 or even 6 months, and the long-term moves lasting anything longer than about 6 months.
For a speculation in stocks, as compared to day-trading or other short-term endeavors, the focus must lie on catching larger waves, make full use of compounding and riding a trend that persists multiple months. This means finding a strong stock when the market is healthy, and latching on to it once corroborating information appears that suggests the move could be viable to join for you. This corroborating data involves clues that tell you a new healthy trend has actually started, and is not a fake rally or random market undulation. We will get later to what that means, but for now, it implies that you will not buy the absolute bottom and sell at the absolute top – the risk/reward ratio is just not viable – but take the middle, “meaty” part out of a move in a leading stock.
Focusing on the middle “meaty” part of a trend
When you study the most successful speculators of the last centuries, you will observe over and over that none of them was ever trying to nail the exact top or bottom in a stock – it’s a fool’s errand. The famous financier and speculator Bernard Baruch stated once “I’ll give you the bottom 10% and the top 10% of any move if I get to keep the middle 80%.” Baron Rothschild is quoted as “Is there a technique for making money on the stock exchange? There certainly is. I never buy at the bottom and always sell too soon“, followed by early 20th century Joe Kennedy’s operating paradigm “Only a fool holds out for the top dollar“.
The stock market is an animal that kills 95% of its prey. A large part of that comes from market participants trying to squeeze every last cent out of a move, and to nail the exact bottom when buying again out of fear of missing out. The problem is that when doing so, like when walking out on a frozen river where ice is continuously thinning, the risk rises astronomically. They will be wrong 95% of the time – when you try to buy a low price in hope of that being the bottom, but the price is overall in a downtrend and you will likely see ongoing price drops thereafter, you will most probably be experiencing losses; when you try to hold out for what you think will be the absolute top, you may lose all your profits again when holding through a small correction that then turns into a large one or a bear market.
As we will see throughout this course, bottoms and tops are formed for specific reasons that can only be spotted in real time and often only slightly in hindsight, thus the rules that you will learn will let you wait for confirmation of a bottom before joining a trend, and to exit a stock before giving your precious profits back. Since the stock market works in likelihoods, we want the odds to be in our favor, and they are certainly not when aiming to nail a bottom or a top. More on this later.
Why focus on the intermediate- to long-term moves?
The simple truth is that we’re in the market to make profits, and the profit potential in relation to the work required to get these profits is the largest in the intermediate- (month-long) to long-term (month- to year-long) trends. This makes sense, when you contextualize that short-term trends only last for a few days or a week or two at most, and can never cover the %-gains that leading stocks deliver in the multi-month trends. On average, a good speculator awaits the right time to enter stocks when the odds are on his side, and trades perhaps 4-5 times a year at best, but then with commitment and power. The rest is careful observation.
Once a position is entered, only the sky is the limit, i.e. as far as the stock will go before showing final topping signs. And if you do it right, which we’ll learn later, you won’t join too late and have to be afraid that the trend is already over. In fact, many strong stocks make 100% moves or higher before they become enter a strong position to be bought by a speculator, only to then march on multiple hundred percent or more in gains. To see 2 examples, look at the charts below. The black bars in the plot represent price development over time. And no, the stocks were not 25 cent penny stocks at the time as the price might suggest – this chart is plotted after many stock splits. Try not to get hung up on the details of the chart … we’ll get there soon enough.
Holding for a multi-month trend also leads to less frustration and emotional drain. As you will see throughout this course, that what is referred to as ‘mental capital’, i.e. sanity and self-confidence in the face of maturing or hostile markets, is key – and requires as much preservation as your financial capital.
Gaining an overview
At this point, let’s briefly summarize the messages of the last few guides. Stock speculation aims to identify the strongest stocks in the strongest price trends (i.e. the stocks with the largest institutional demand) that amplify an established uptrend in the general market by large multiples, and any profits with it. The speculator attempts to capitalize on the intermediate- to long-term parts of that trend with relatively little amount of activity and vigilant “riding” of a winning position until the trend reverses.
The profits are larger in those trends, because the trends that you speculate in are larger, and because of specific money- and risk management principles such as limited pyramiding – which we will learn later.
Speculation in stocks commonly assumes that stocks are bought and held for many weeks and months, whereas the classical definition of the long-term “investor” says he will hold stocks for years or decades, or that “traders” will hold for days to weeks. While these are the rules of thumb of how long you would aim to hold a stock, you would do well to forget about these time-frames and boxes that people put themselves in, as you will learn in this course that the only thing that determines how long or short a stock position should be held on to, whether that’s only a single day or 3 years, is its own behavior – not a definition of what a trader or an “investor” should do.