On paper, investing seems easy enough. Stock prices fluctuate. All you have to do is simply buy a stock and sell it at a higher price. It’s a magical idea. Just repeat until wealthy.
Philip Carret outlines the typical experience a novice investor goes through as they come to realize investing is not nearly as easy as it appears on paper.
The novice learns that no such simple plan of operations as this will work. His experience, however, does not shake his confidence in the axiom that stock prices are consistently fluctuating. Indeed, the next stage of progress of the novice — a stage beyond which many traders never get at all — comes with the observation that the prices of securities fluctuate considerably from day to day and week to week.
A confident novice is a deadly combination. With all those stocks flopping around which do you buy? The one you hear about, of course.
Impatience is his dominating characteristic. The money that he has decided to risk in the stock market is burning a hole in his pocket. Having opened a brokage account he seeks eagerly for a suggestion as to a purchase. Perhaps a business friend who is quite as much of an amateur supplies a tip, perhaps he hears a tip circulating in the board-room of his brokerage office, he may find a suggestion that appeals to him in his broker’s market letter or he may consult a customer’s man in the brokerage office. Whatever the source he is sure to receive a tip very shortly unless he is both deaf and blind.
We’re all biased towards action. We’re also drawn to shortcuts. An (over)confident amateur with a “hot” tip and idle money in a new account doesn’t stand a chance.
But what does the novice do after they buy? What happens if there’s a quick move higher? Sell and take the small profit? Hold on for more gain? How about a move lower?
One thing is certain, the reason for buying — a tip — offers no help in knowing when to sell. The mental hurdles begin after the purchase.
If a trader could select the stock which is to be the star performer for the next week or two, take his profit on that and move on to the next, he would actually find the stock market the road to fortune that many people think it is. How shall the trader select of the thousand stocks traded in the one issue which will have the largest movement in the next week or two? Nothing short of omniscience will enable him to do it. Yet this is exactly what thousands of traders are constantly trying to do. Impatiently they jump around from one stock to another taking a small profit here or a loss there and doing no better in the long run than make commisions for their brokers. A psychological factor here enters. Having no sound reason for his purchase than a tip the average trader has little courage and is easily frightened into taking small profits. On the other hand, he is stubborn enough to feel that any stock he has purchased must at least be worth what he paid for it. He is likely, therefore, to hold on grimly in a declining market and at the end of year find that it took a good many five or ten-point losses, commissions, transfer tax, and interest charges.
…
The explanation is probably to be found in the tardiness with which the mind adjusts itself to changing ideas of value. Suppose a trader buys at 70 a stock which has already advanced from a previous low of 49. Every point further advance is, so far as his previous experience goes, a step into uncharted ground. Any sign of hesitation in the market, particularly if he is operating in large part on borrowed money, leads him to act on the proverbial advice that a bird in the hand is worth two in the bush. On the other hand, the fact that he has actually paid 70 for the particular stock automatically establishes that figure in the mind of the average trader as representing something like its true value. It is one known spot in uncharted ground. Though the stock may stray away from it in the wrong direction the average trader will be slow to believe that prospects of its return are dubious.
When you buy for the wrong reasons, it’s that much easier to compound mistakes. Unlike, buying a stock because it’s selling for less than its worth, with a “hot” tip, the price paid becomes the deciding factor for what to do next.
It typically leads to excessive trading that compound costs and losses rather than profits.
Trying to predict price movement in the short term is nearly impossible. Trying to profit from it is a lesson in futility. Here’s Carret with the last word.
Perhaps enough has been said to indicate the principal difficulties which beset the speculator who attempts to profit by the short swings of the stock. For practical purposes the occurrence of ripples and waves in the price movement is unpredictable. To attempt to trade on such movements is mere gambling with the odds against the trader by a considerable margin. It is astounding that thousands of otherwise intelligent persons persist in trying to make money in this way… The deep-seated gambling instinct, the well founded belief that in widely fluctuating markets there must be opportunities for profit nevertheless bring fresh recruits to the brokerage offices in constant streams. A few of them ultimately learn the methods by which money may be made in the stock market.
Source:
The Art of Speculation: Market Movements – Ripples and Waves — Barron’s 11/1/1926
