Dear Fellow-Investor.
Why do totally overvalued and overrated stocks go up and up while cheap high quality stocks often come to a standstill?
At the stock markets, more often than not, the brain is being switched off and the rational thinking stops – which is risky and can cost a lot of money!
It’s the same over and over again. If a stock makes a lot of profit investors tend to fall hopelesly in love with a security. But when it drops, many of us just look at the bad news and just tend to see dark clouds in the sky and act accordingly by selling instead of scrutinizing the fundamental data and the perspective of such corporation.
They are being led by emotions i.e. psychology. Where proper action is required, hunches and gut feelings take over instead of switching the brain back on!
Science and research has scrutinized what is called “Behavioral Finance” to find answers to why and how investors come to such irrational behaviour. They try to find out what makes investors “tick” and why a lot of them throw their money at high risk securities like OTC (over the counter) stocks.
Rational thinking was also highly neglected during the late 90’s and greed took over. Many newbies to the stock market observed how the markets where skyrocketing and they bought just almost any stock that promised to rise without thinking and taking even the slightest fundamentals into consideration. It was almost compulsive to buy securities!
While, during the boom of the 90’s, almost everyone rushed and charged at what I call “scrap stocks” - no matter how expensive they were - no one was interested in the cheaper but high quality stocks that were available for “give-away-prices” during the 3 year resession that followed.
This is totally irrational! Nobody was interested in the best stocks around that were out there at discount prices because some of them had dropped 70, 80 or even 90%.
For centuries investors have made the same mistakes over and over again! They are being led by emotions. Most of them sell stocks that have been doing well way too soon – happy to have made a profit that they don’t want to lose anymore.
On the other hand, the same investors hold on to losing positions way too long. They don’t like selling at a loss because this would mean owning up to the fact that their investment decision was a mistake. And who likes making mistakes?
But this is one of the most important lessons investors have to learn: It’s only worth while holding on to securities - that have dropped - which are of high quality and where the chance of a turn around is more likely than not!
Behavioral finance also found out that most investors already make their first mistakes during their research when they start looking for information about their future investments. If they expect a stock to go up they overrate good news more than bad. And by the same token, if they expect a stock to fall, they overrate bad news more than the good ones.
Financial gurus like Peter Lynch, Warren Buffett or Andre Kostolany have always said that, on short-term, only 10% of what is said and thought at the financial markets is based on fact. Everything else is psychology that lead to the same mistakes over and over often because most investors, especially the private ones, have no strategy and are extremely susceptible to all the background noise and mumbo-jumbo that is poured upon them.
If you want to be a successful investor you have to switch off your hunches and gut feelings, not your brain! And you have to develop a strategy!
Yours in Successful Trading
Ricky Schmidt
www.stockbreakthroughs.com
www.stockbreakthroughs.com/option