People like cause and effect. People misuse reasoning tools to find and rationalize the causes of stock price changes. Price is, at best, an approximation of value and at any time there may be many factors involved in its creation.
The recent market meltdown is an interesting study in psychology. How does it happen that people misinterpret price signals?
Let’s look at some factors about how things work so far.
If a stock buyer or seller is driven by signals from the amygdala, the primitive brain, the part that governs fight and flight, should we expect higher brain, rational outcomes? Probably not. So what to do?
Notice that a stock has two pricing mechanisms.
Method 2) is difficult and demanding work. Method 1) is easy. Which do you suppose was applied over the weekend of 22 and 23 August?
If you sold Apple at the open on Monday morning and bought back at the open on Thursday when the fear had subsided, you would have lost 18% of your money. Clearly, the investigate, then buy and hold method would have served you better.
There is an enormous amount of information that points to buy and hold as the proper methodology for most investors.
The short game can make money too but those that play the short game need some skills:
I have a seen only a single person with most of those skills. The application of them, while generally profitable, was not without spectacular failures.
Buy and Hold seems to work, but it is hard work and boring. The other techniques of “Shuck and Dive”, “Run and Hide”, “Duck and Cover” may not fulfill your purpose.
Few are able to make money based on better information, sooner and with an understanding of how people will react to it. Price is therefore, a poor indicator of value. If you understand value, then price can help you. Sell to the greedy at high prices and buy from the fearful when low.
But, you do need to know what the real value is and you need someone to talk you in off the ledge when the others become irrational.
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Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.