Monday, April 9, 2012

The Art of Speculation Series 6 - Never Panic Buy or Sell

As an investor we need to keep a clear head at all times and not influenced by the daily gyrations of the financial markets. This is due to the shifting from fear to greed and vice versa by the crowd. It is not easy to avoid being caught up in a stampede in the different end of the bull and bear markets. Nobody wants to be left behind during a bull or a bear market rush where the herd is moving. So it is very important to keep your head when others are about to lose theirs.

Never follow the Crowd

This is important because we tend to follow the crowd wherever they move because it is an inbuilt instinct that had been cultivated among us. When we are small our parents always teach us to follow rules and regulations. Don’t walk alone at night, go fishing alone, go swimming alone and so on. Always go with a group so everybody can keep an eye on everybody. So in a way group behavior had been ingrained into our mind and hence our decision making. Instead of having to make decisions individually we tend to follow the herd because it is the safest.

However in the investment world you must trust no one, in your decision making process. Following the crowd is normally a wrong decision. More wrong stocks are sold during panic selling in crisis and bought during panic buying in bull markets than any other times. There are too many tales to be told where folks are making hugh losses due to their bad decision making.

Panic Selling

An example is during the assassination of President Kennedy, the market lost 25% in one week and there is a deluge of panic selling. Everyone wants to get out, primarily because of uncertainty surrounding the stock market, fear, confusion and lack of confidence are the only thoughts in the minds of investors. Losing your mind during such period will certainly means losing your money. Within three years after the assassination of JFK, the S&P rose more than 21%.

Similarly after the 9/11 terrorist attack on the twin towers, the NYSE was closed from September 11 to September 17. On reopening the Dow Jones (DJIA) lost more than 7% or 684 points, resulting in more than $1.4 trillion being wipe out in that week. The airlines and tourism industries were the hardest hit because of fear of another attack. However, the stock market recovered fairly quickly and reached an all time high in 2006.

Panic selling does not only apply to the stock market as a whole but also on individual companies. There are many times companies faced with unforeseen circumstances which might lead to lower or cut dividends completely, earnings lower than expected, strike by workers and etc. A lot of people upon getting such news will start liquidating their shares without even border to check for the reasons. Most of the time you will find that a few days after the announcement the stock price will rebound back to or higher than the original price. The reason being insiders, shrewd investors and other people in the know had already sold their shares at the higher price before the announcements. When the news is announced they have the pleasure of relieving those investors who panicked by buying their shares at a lower price.  

Panic Buying

On the other side of the coin there is always the panic buying by investors. Panic buying occurs when there is good news announced like a contract is sealed, a merger and acquisition exercise, a strike had been settled, a discovery of large mineral deposit and etc. This is the time where investors felt that they don’t want to be left behind in the anticipated price hike in the shares. People just rush in and start bidding the share price to ridiculously high price. End result will surely be profit taking and will result in a much lower price in the next few days.

The bigger danger of panic buying is during the end of a bull run. Normally a bull run ends with a parabolic run up in the share prices. During such times volume are normally very heavy because every investors wants to have a bit of the action. Parabolic runs normally end in tears. This is the time where stock promoters are out in force and newspapers headlines are always about the market that is making new highs week after week. This is where most of the panic buying occurs because no one wants to be left out. This is the sign that serious troubles are ahead because by the time the bubble burst these investors are the last to get out.

Maintain a Cool Head

However as an astute investor, we need to look out for signs of panic buying and don’t join in the rush. Instead we should maintain a cool head and will always provide the pleasure by relieving those investors of their shares when panic sales ensue later.

However as for us getting into such frenzy buying and selling a few times in our career in investing, is a prerequisite for our learning process before we settle down in the business of making serious money.

The Tao Of Trading

Making mistakes is part of our self development in our transformation from being an amateur trader to a master trader. Our ultimate aim in trading the markets is to achieve what we call the ‘Tao Of Trading’. When you reach this level your mind is in a state of calm and serenity. Your approach to the market is different even during the market crash because you already anticipated the event before it happened.

Anyway to reach the ‘The Tao Of Trading’ mindset is not easy. You have to go through different stages of internal development. It took me more than 10 years of losing in the market in order to understand almost all possible ways to lose. Yes folks, the idea is to learn all possible ways to lose. I am still losing in some of my trades today but the most important thing is I make sure that my portfolio come out positive at the end of the period. 

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