Don"t Be Dumb Money in Stock Market
I suspect a large number of investors who believe they can make money by jumping on winners and dumping losers fall into the category of "dumb money."
Dumb money is a term some of the more sophisticated traders use to describe easy pickings in the stock market.
Dumb money may be a little harsh, but there is a ring of truth to it when you observe the actions of investors who believe the way to make money is to buy low and sell high, but usually do just the opposite.
In the stock market, an old saying is often corrupted into: "a stock that goes up will go up forever and a stock that goes down will continue going down."
Or, if you're a real optimist: "a stock that drops like a rock will bounce back tomorrow … or soon."
In either case, investors lock their minds into concluding the movement in some direction of a stock sets its course for the future.
This explains why they have no problem buying a stock that has just run up 45 percent and assuming it will keep growing at that rate forever. Witness Apple which began 2012 around 413, zoomed up to 700+ and closed 18 months later at about 440.
During its dramatic rise from the beginning of 2012, which saw two peaks in price - one at about 630 and the other a hair over 700 - there was talk of it continuing to 1,000 and beyond.
Smart money traders made a lot of money on the investors who jumped in as the stock was nearing one of the peaks by selling all or most of their holdings and watching the price plummet back to reality.
One of the few Wall Street clichés that makes sense cautions investors to "sell when others are buying and buy when others are selling."
Most who follow Apple closely and did their homework didn't believe the intrinsic value of the company supported a $700 per share price.
Investors read about a stock's rapid rise and want in on the action. Unfortunately, if they don't do their homework they may not know that the stock has been run up way past its intrinsic value and it set up for a major sell-off as investors who got in early take their profits and run.
A stock that shows a period of rapid growth seldom maintains that same rate for an extended period. If the stock is pumped by the rapid growth of the company, it may be hard for the company to continue at the same pace. The larger the company gets, the harder it is to grow the company by significant percentage increases.
This mindset also explains why investors dump a stock at the first bad quarter or dip in stock price - the stock must surely be headed downhill forever.
If you don't know the company's business, it is easy to get spooked when a few bad numbers show up on quarterly reports. However, if you know something about the company, you'll understand the numbers better and be able to decide whether a poor quarter is just a bad quarter or the beginning of bigger troubles. One bad quarter is usually not a reason to dump a quality stock.
However, you don't want to be blinded to a company's faults. If the company has significant problems that don't seem to be addressed by the management, you shouldn't hold on with the hopes that things are going the change. Companies do pull out of tough spots, but you need to be realistic about those chances of it happening.
Don't get caught in the trap that just because a stock is headed one direction means it is locked onto that path forever. One bad quarter is not the end of the world, however a consistently losing proposition of a business usually won't improve with extra volume.
Dumb money is a term some of the more sophisticated traders use to describe easy pickings in the stock market.
Dumb money may be a little harsh, but there is a ring of truth to it when you observe the actions of investors who believe the way to make money is to buy low and sell high, but usually do just the opposite.
In the stock market, an old saying is often corrupted into: "a stock that goes up will go up forever and a stock that goes down will continue going down."
Or, if you're a real optimist: "a stock that drops like a rock will bounce back tomorrow … or soon."
In either case, investors lock their minds into concluding the movement in some direction of a stock sets its course for the future.
Buying Stock
This explains why they have no problem buying a stock that has just run up 45 percent and assuming it will keep growing at that rate forever. Witness Apple which began 2012 around 413, zoomed up to 700+ and closed 18 months later at about 440.
During its dramatic rise from the beginning of 2012, which saw two peaks in price - one at about 630 and the other a hair over 700 - there was talk of it continuing to 1,000 and beyond.
Smart money traders made a lot of money on the investors who jumped in as the stock was nearing one of the peaks by selling all or most of their holdings and watching the price plummet back to reality.
One of the few Wall Street clichés that makes sense cautions investors to "sell when others are buying and buy when others are selling."
Most who follow Apple closely and did their homework didn't believe the intrinsic value of the company supported a $700 per share price.
Investors read about a stock's rapid rise and want in on the action. Unfortunately, if they don't do their homework they may not know that the stock has been run up way past its intrinsic value and it set up for a major sell-off as investors who got in early take their profits and run.
A stock that shows a period of rapid growth seldom maintains that same rate for an extended period. If the stock is pumped by the rapid growth of the company, it may be hard for the company to continue at the same pace. The larger the company gets, the harder it is to grow the company by significant percentage increases.
Selling Stock
This mindset also explains why investors dump a stock at the first bad quarter or dip in stock price - the stock must surely be headed downhill forever.
If you don't know the company's business, it is easy to get spooked when a few bad numbers show up on quarterly reports. However, if you know something about the company, you'll understand the numbers better and be able to decide whether a poor quarter is just a bad quarter or the beginning of bigger troubles. One bad quarter is usually not a reason to dump a quality stock.
However, you don't want to be blinded to a company's faults. If the company has significant problems that don't seem to be addressed by the management, you shouldn't hold on with the hopes that things are going the change. Companies do pull out of tough spots, but you need to be realistic about those chances of it happening.
Conclusion
Don't get caught in the trap that just because a stock is headed one direction means it is locked onto that path forever. One bad quarter is not the end of the world, however a consistently losing proposition of a business usually won't improve with extra volume.
