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Stock Market Rules
The 50 Most Widely Held Investment Axioms Explained, Examined, and Exposed
By Michael D. Sheimo
The McGraw-Hill Companies, Inc.Copyright © 2013Michael D. Sheimo
All rights reserved.
Get Information Before You Invest
Most of the complicated aspects of our lives could be made simpler if we gathered information before we took action. Asking why, how, where, and what is important when deciding to invest in stock:
Why is this stock attractive to us? Is it soaring to new highs, or has it suddenly dropped lower in a way that seems unrelated to the overall market?
How is that price going to recover or keep moving up?
Always be asking, Where is the new business going to come from?
What has happened to create the current situation, and is it for the long term or is it just a short-term anomaly?
This approach will help you avoid a shoot-from-the-hip approach to buying stock or becoming totally dependent on the inconsistent wisdom and opinions of others.
Depending entirely on the opinions of others or shooting from the hip can lead to many misunderstandings. Misunderstandings cause bad timing and poor, ineffectual strategies. Although investment advice can be helpful, it can be even more useful as a point of reference—as a second opinion—and shouldn't be accepted as the only approach.
In the stock market, the odds of doing well are improved for the investor who becomes familiar with the current action of the market and the particular stock of interest. You can become familiar with the action by asking why:
Why is the market making this move?
Why is this stock an attractive purchase now?
YOU CAN DO IT
Peter Lynch, the legendary former manager of Fidelity Magellan Fund, put it very succinctly when he said, "Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it."
Yes, it's the old, "Are you smarter than a fifth grader?" idea. Actually it's even a little easier than fifth-grade math. In fact, the stock market pretty much got rid of fractions (the eighths) just to make it easier.
The stock market is a continuous auction with the same product being bought and sold every business day. If there are more buyers than sellers, the market and the prices of individual stocks rise. If there are more sellers than buyers, prices fall. It's that simple.
But if it's so simple, then why does it seem so complicated? Why are all these investors buying and selling stock? If they're investors, shouldn't they all be buying and holding stock for its investment value? Why are people surprised when the stock market drops a few hundred points? Does a severe market correction mean that the economy will take a nosedive?
The newscasters always say that the stock market forecasts the economic situation six months to a year away. So what gives?
The most important fact to remember is that the stock market always trades on anticipation of future events, and they always change. Professional investors are looking ahead six to twelve months, but (and here's the kicker) not always. Although the market might react strongly to some negative news, it is capable of dropping severely one day and more than recovering the next day. If the Dow Jones Industrial Average is down 50 or a couple of hundred points or more, the major investors don't care about what might happen in six months. They are concerned only with what might happen in the more immediate future—that being the next ten minutes. The faster the market drops, the shorter their focus becomes.
The believers of doom and gloom busily pat themselves on the back for being correct, and those who know better take a more moderate stance. Thankfully, it usually takes more than an overcorrection in the market to cause an economic recession.
REAL, IMAGINED, AND FABRICATED FACTORS
A real factor that motivates stock market buyers and sellers is money, specifically the availability of money. Money availability changes with the movement of interest rates and the earnings of corporations. This is partly why the economy and the stock market have had some serious problems in the last few years. Problems with mortgage loan defaults caused significant reductions in the money supply. Unemployment interfered with economic cash flow, again affecting the money supply. News of unemployment often affects the entire stock market. If the news is good, the market goes up. If unemployment increases, the market drops. Obviously, higher interest rates can be another negative factor that relates to decreased money availability. Negative news on money availability can have a strong influence on the movement of the overall market. Sometimes it's short term, and other times it can last for a longer time.
An imagined factor can be the respected opinion of an economist or market analyst concerning the current strength of the stock market. Ben Bernanke, current chairman of the Federal Reserve might make a less than positive statement about the economy. This would cause the market to take a dive. If this happens, sometimes recovery comes the next day; other times it can take a few days. Although Mr. Bernanke is not the only one to influence the stock market, he is often the most important. Frequently the effect of his comments lasts only a few days, after which the market moves on to other news.
A fabricated factor is the merciless hammering of computerized sell programs. These programs are operated primarily by large hedge funds and kick in during predetermined market conditions. They have nothing to do with investing or market values. They are based on price conditions and are as close to stock market manipulation as we get. At times, the market drops straight down from the opening, bottoms out, and then runs flat or begins to rise again. At times it rises a small amount only to fall further. The rise is usually referred to as a "dead cat bounce."
The sells are often implemented with the intent of testing market strength by pushing the market down as far as possible. "As far as possible" is a point that is reached when buyers enter the scene and stop the decline; that point is called "support." Professional stock traders in large funds or hedge funds like to see volatility in the stock market so they can play both sides and make money whether the market rises or falls. Most individual investors lack the resources, knowledge, or experience to do that kind of trading.
Investors who noticed the turn in the stock market by observing the daily decline in the S&P 500 Index (see Figure 1.1) or the Dow Jones Industrial Average and who listened to the market opinions given by many analysts before March 2008 would likely have taken some protective action. Market anticipation had been fueled by a strong economy, and that was a bubble starting to burst. When the bad news came out, it became a deluge of selling. The housing bubble exploded in a tsunami of defaults on loans. And the crooks were all exposed as the tide rushed back out. The S&P 500 Index went from 1,565 in March 2007 to 676 in March 2009 (see Figure 1.1), losing more than half its value in two years.
STOCK MOVES: DOWN
Buying a car, a computer, or a new television only to see it on sale the following week can be a huge source of irritation to a consumer. The same holds true for stocks. To pay $52 a share one day, and then hear some negative news and see a price of $42 the next week is not a pleasant experience. If your research and selection are valid, the price will probably recover and move to new highs. But the price damage on the way down can be difficult to
Excerpted from Stock Market Rules by Michael D. Sheimo. Copyright © 2013 by Michael D. Sheimo. Excerpted by permission of The McGraw-Hill Companies, Inc..
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