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Buy Low, Sell High (Fear & Greed)
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billywows
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19-Aug-2006 22:57
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Take advantage of the herd A little thing called value investing -- preached by a few luminaries you may have heard of (Graham, Buffett) -- can help you buck such a herd mentality. Value investing uses financial metrics to discover great companies with the potential for long-lasting returns. But it works only if you wait for the rainy day when the market panics (FEAR) -- and buy the stock at a discount to its intrinsic value. |
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billywows
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19-Aug-2006 22:43
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Interesting read for the weekend .... :) Fear and greed Because of this, emotions play a huge role in people's actual investment decisions. By far, fear and greed loom the largest. When a stock is going down, people's natural tendency is to get scared. After all, it's their money on the line, and they have plans that will fall apart if the cash isn't there when it's needed. As such, folks tend to want to sell a falling security to preserve whatever remains of their capital. What this means is that it does often make selloffs far more dramatic than they should have been. As a result, you can snap up shares for far less than they're truly worth. After all, it's called a panic sale for a reason. Just like a department store trying to rid itself of "scratch and dent" merchandise, fear causes the stock market to sometimes offer incredible bargains on companies that are only slightly damaged. As a value-focused investor, you can take advantage of this mispricing to profit. On the flip side, when stocks are performing exceptionally well, investors tend to want to pile in on the action. Just as fear sends people running from a stock heading down, greed compels them to buy one that's rising. The resulting buying frenzy frequently drives a company's stock dramatically higher than it's truly worth. Unfortunately, just as everyone wants to purchase, the stock becomes its most dangerous. At a high-enough price, there's nothing but hope supporting the stock. As a value investor, that's your opportunity to sell or your cue to stay away. The consequences The upshot of all this emotionally driven buying and selling is that stocks tend to trade both well above and well below their true worth from time to time. You can see this by looking at something that I like to call the emotion factor. In essence, it's a comparison between the 52-week low and high prices of a company and its expected five-year growth rate. The higher the price changes compared with the growth rate, the more likely it is that emotion is involved. |
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