Let’s do something ill-advised: Let’s not invest using Value Investing strategies. Let’s invest using short-term, non-value based methods instead. Let’s become short-term traders. Unfortunately, when I started out, that’s exactly what I did.
Back in the early 1990s I thought I was going to make a lot of money in the stock market very quickly using short-term trading strategies. I had some seed money, computer programming skills and access to historical data for thousands of stocks. I figured it would be super-easy to write a program to analyze these data and come up with an algorithm that would significantly beat the stock market. I mean what could go wrong? And nothing went wrong – until I used my new algorithm to purchase an actual stock with real money.
Then, almost immediately, the stock price went down quite a bit. And my heart sank. I didn’t have a plan for a stock that fell 25% in the first panic-stricken week I owned it.
The problem was I didn’t know how to value a company so I had no idea what the stock was worth. Was it worth the price I had paid? Was it a better value at 25% off or was it just a bad stock whose price had declined to better reflect its weaknesses?
I had no idea.
But that information was supremely important. If the stock was an excellent one with terrific prospects but had been beaten down because of illogical reasons, then it would be good to pick up more shares.
On the other hand if the company was bleeding cash and heading for difficult times and the price had fallen to reflect this, I would be better off selling the shares I had and taking a loss in order to protect my portfolio from a far greater loss.
But without the right information I was just guessing. My algorithm that was supposed to predict prices based on historical data obviously wasn’t working. And since it didn’t take into account any fundamentals or valuations, I didn’t know if the company was strong or not. In fact I didn’t even know what the company did. I had just picked it based on its current price relative to its historical prices.
That’s not much different than what many so-called investors do today. They invest in stocks based on what they’ve heard on TV or read somewhere on the Internet. They don’t know if the underlying company is good or bad and they don’t know how much a share is worth. Most couldn’t even tell you what the company does and just about all would have no idea what the current ratio is or whether the company’s cash flow position is strong or not or even what its dividend payout ratio is.
Fortunately this happened to me more than 15 years ago and I learned my lesson. Not everyone learns however, and most continue investing using the same illogical and unprofitable methods throughout their lives.
But I learned. I learned that stocks are no different than anything else. When you purchase a car, you first determine its value before laying down the cash. Yes, you might end up paying a few hundred dollars more than someone with better negotiating skills, but at the end of the day you pay close to what the car is valued at.
Nobody pays a Ferrari price for a Kia. Even the least skilled car buyer knows how to do rudimentary research to arrive at a particular car’s fair value.
The same goes for groceries and toothpaste and furniture and pretty much everything else we use every day. When things go on sale, we buy more. When prices rise we purchase less.
That’s because we have a good idea of what these things are worth and can therefore spot a good deal.
Unfortunately that’s not the case with stocks. The majority of people don’t know what a particular stock is worth. So they can’t determine when it’s on sale or when it’s too expensive. They end up acting illogically, giving into fear by selling when prices fall and becoming consumed by greed and buying more when prices rise. They buy high and sell low.
This is the exact opposite of what they do when purchasing other items in their lives.
So if they use logic to determine these other items’ value before purchasing them, what makes stocks so different that they don’t feel the need to do it for them?
Stocks are the same as any other big-ticket purchase and therefore you should treat them the same. If you don’t, you’ll end up losing money and delaying your true investment success.
It’s never too late to turn your investment strategies around and improve them. So start today.
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