By Haddon Libby
With so many people at home nearly 24-7, it should be no surprise that many people find the stock market to be a lot like a video game. Even though many investors have had great success of late, many are taking risks that are not being understood.
The first thing to remember when investing is that short-term trading is very different than long-term investing. When engaged in high-risk, short-term trading, do not put at risk an amount that you cannot afford to lose.
If you decide to buy an option contract, calculate your best case and worst-case scenarios and know exit points in both cases. Unless you know the full risk that you are taking, there is a very good chance that you will learn the hard way.
Like Kenny Rogers once sang, ‘You got to know when to hold’em, know when to fold’em’. If you prefer meat-based references, ‘pigs get fat while hogs get slaughtered’.
Bias. Everyone has bias. The trick to being a good investor is eliminating bias from decision making. As an example, if you put all of your money into cash just before the Presidential election, you would have missed out on a 19% increase in the S&P 500 and 17% in the Dow. Somehow the market did not crash despite a change in administration and a failed pseudo-coup.
Like many people whom you know, recognize that the stock market is not always logical. For Tesla to have a market value that is larger than all other publicly-traded auto companies makes no financial sense. Then again Tesla has batteries and future technologies that seem impressive but they also have an awful lot of competition coming down the E-turnpike. Can a company that sells 500,000 cars a year and relies on tax incentives for its profit margins to be worth more than the rest of an industry that sells 87 million in cars?
Gamestop is another company with a recent valuation that bore no resemblance to reality. At one point during the rise, each Gamestop store was valued at nearly $5 million…pretty good for a company that was called the Blockbuster of the 2020s, huh? The issue here was that hedge funds bet that the company was going into bankruptcy and made stock bets (shorted the stock) expecting that outcome. When an army of investors started buying up the limited amount of stock that traded in this company, the hedge funds could not get their hands on enough Gamestop stock to cover their positions and suffered $20 billion in losses as reported by S3 Partners.
The hedge funds prove that even the ‘smartest’ investors can be surprised. Never bet the proverbial farm on a limited number of ideas. Diversify. Seek out advice from those more experienced (Reddit blogs do not count).
There is another old adage that goes, ‘if I like a stock at $50/share, I will love it at $40/share’. If you understand the stock and the reason for the decline, a significant dip may be a great time to buy a stock. A surprise dip can also indicate that you do not understand what is happening with the stock. Anyone who ever held a stock like Blockbuster or MCI knows that today’s hot stock can be tomorrow’s dud due to changing trends or something unexpected like fraud.
If someone told you that a pandemic was coming, you would naturally assume that stock prices would go down. Would you expect stocks to fall by a third before rallying to all-time highs all while the pandemic was still raging?
When investing, remember the words of investing legend, Warren Buffett – “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”