Anybody who sells stocks because the market is up or down is a market timer for sure.

Anybody who sells stocks because the market is up or down is a market timer for sure.

A market timer tries to predict the short-term zigs and zags in stock prices, hoping to get out with a quick profit. 

Few people can make money at this, and nobody has come up with a foolproof method. 

In fact, if anybody had figured out how to consistently predict the market, his name (or her name) would already appear at the top of the list of riches peole in the world, ahead of Warren Buffett and Bill Gates.

Try to time the market and you invariably find yourself getting out of stocks at the moment they've hit bottom and are turning back up, and into stocks when they've gone up and are turning back down. 

People think this happens to them because they're unlucky.  In fact, it happens to them because they're attempting the impossible.  Nobody can outsmart the market.

People also think it's dangerous to be invested in stocks during crashes and corrections, but it's only dangerous if they sell.

They forget the other kind of danger - not being invested in stocks on those few magical days when prices take a flying leap. 

It is amazing how a few key days can make or break your entire investment plan. 

Here is a typical example:  During a prosperous five-year stretch in teh 1980s, stock prices gained 26.3% a year.  Disciplined investors who stuck to the plan doubled their money and then some.  But most of these gains occurred on 40 days out of the 1,276 days the stock markets were open for business during those 5 years.  If you were out of stocks on those 40 key days, attempting to avoid the next correction, your 26.3% annual gain was reduced to 4.3%.  A CD in a bank would have returned more than 4.3%, and at less risk.

So to get the most out of stocks, especially if you're young and time is on your side, your best bet is to invest money you can afford to set aside forever, then leave that money in stocks through thick and thin. 

• You'll suffer through the bad times, but if you don't sell any shares, you'll never take a real loss. 
• By being fully invested, you'll get the full benefit of those magical and unpredictable stretches when stocks make most of their gains.

Secret formula for winning was always staring in your face

People are always looking around for the secret formula for winning on Wall Street, when all along, it's staring them in the face: Buy shares in solid companies with earning power and don't let go of them without a good reason. The stock price going down is not a good reason.

To get that 11%, you have to pledge your loyalty to stocks for better or for the worse - this is a marriage we're talking about, a marriage between your money and your investments. You can be a genius at analysing which companies to buy, but unless you have the patience and the courage to hold on to the shares, you're an odds-on favorite to become a mediocre investor.

It is not always brainpower that separates good investors from bad; often, it's discipline.

Invest for the Long Term - Twenty years or longer is the right time frame.

If you can read and do fifth-grade arithmetic, you have the basic skills to be a successful investor in stocks.  The next thing you need is a plan.

The stock market is one place where being young gives you a big advantage over the old folks.  You've got the most valuable asset of all - time.

The old expression "Time is money" ought to be revised to "Time makes money."  It is a winning combination.  Let time and money do the work, while you sit back and await the results. 

If you have decided to invest in stocks above all else, avoiding bonds, you have eliminated a major source of confusion, plus you've made the intelligent choice.  This assumes, you are a long-term investor who is determined to stick with stocks no matter what. 

People who need to pull their money out in one year, two year, or five years shouldn't invest in stocks in the first place.  There's simply no telling what stock prices will do from one year to the next.  When the stock market has one of its "corrections" and stocks lose money, the people who have to get their money out may be going home with a lot less than they put in.

Twenty years or longer is the right time frame. That's long enough for stocks to rebound from the nastiest corrections on record, and it's long enought for the profits to pile up.  11% a year in total return is what stocks have produced in the past.  Nobody can predict the future, but after 20 years at 11%, an investment of $10,000 is magically transformed into $80,623.

To get that 11%, you have to pledge your loyalty to stocks for better or for the worse - this is a marriage we're talking about, a marriage between your money and your investments.  You can be a genius at analysing which companies to buy, but unless you have the patience and the courage to hold on to the shares, you're an odds-on favorite to become a mediocre investor.  It is not always brainpower that separates good investors from bad; often, it's discipline.

Stick with your stocks no matter what, ignore all the "smart advice" that tells you to do otherwise, and "act like a dumb mule."  That was the advice given 50 years ago by a former stockbroker, Fred Schwed, in his classic book Where are the Customers' Yachts? and it still applies today.

People are always looking around for the secret formula for winning on Wall Street, when all along, it's staring them in the face:  Buy shares in solid companies with earning power and don't let go of them without a good reason.  The stock price going down is not a good reason.

It's easy enough to stand in front of a mirror and swear that you[re a long-term investor who will have no trouble staying true to your stocks.  The real test comes when stocks take a dive.  Nobody can predict exactly when a bear market will arrive (although there's no shortage of Wall Street types who claim to be skilled fortune tellers in this regard).  But when one does arrive, and the prices of 9 out of 10 stocks drop in unison, many investors naturally get scared.

Consistently losing money in stocks - don't blame the stocks, it is not the fault of the stocks. You need a plan.

When people consistently lose money in stocks, it's not the fault of the stocks.

Stocks in general go up in value over time.

In 99 out of 100 cases where investors are chronic losers, it's because they don't have a plan.

They buy at a high price, then they get impatient or they panic, and they sell at a lower price during one of those inevitable periods when stocks are taking a dive.

Their motto is "Buy high and sell low," but you don't have to follow it.

Instead, you need a plan.

Groundwork for a lifetime of investing in Stocks

The Pros and Cons of some basic investments.

Stocks

Stocks are likely to be the best investment you will ever make, outside of a house. 

When you buy a bond, you're only making a loan, but when you invest in a stock, you're buying a piece of a company.  If the company prospers, you share in the prosperity.  If it pays a dividend, you'll receive it, and if it raises the dividend, you'll reap the benefit.  Hundreds of successful companies have a habit of raising their dividends year after year.   This is a bonus for owning stocks that makes them all the more valuable.  They never raise the interest rate on a bond!

Stocks have outdone other investments going back as far as anybody can remember.  Maybe they won't prove themselves in a week or a year, but they've always come through for the people who own them.

More than 50 million American have discovered the fun and profit in owning stocks.  That's one in five.

These aren't all whizbangs who drive Rolls-Royces.  Most of these shareholders are regular folks with regular jobs:  teachers, bus drivers, doctors, carpenters, students, your friends and relatives, the neighbours in the next apartment or down the block.

You don't have to be a millionaire, or even a thousandaire, to get started investing in stocks.  Even if you have no money to invest, because you're out of a job or you're too young to have a job, or there's nothing left over after you pay the bills, you can make a game out of picking stocks.  This can be excellent training at no risk.

People who train to be pilots are put into flight simulators, where they can learn from their mistakes without crashing a real plane.  You can create your own investment simulator and learn from your mistakes without losing real money.  A lot of investors who might have benefited from this sort of training had to learn the hard way, instead.

Friends or relatives may have warned you to stay away from stocks.  They may have told you that if you buy a stock you're throwing your money away, because the stock market is no more reliable than a casino.  They may even have the losses to prove it.  Looking at the annual rates of returns of selected investments, stocks been the best performers, averaging 11% annualy over decades.  If stocks are such a gamble, why have they paid off so handsomely over so many decades?

When people consistently lose money in stocks, it's not the fault of the stocks.  Stocks in general go up in value over time.  In 99 out of 100 cases where investors are chronic losers, it's because they don't have a plan.  They buy at a high price, then they get impatient or they panic, and they sell at a lower price during one of those inevitable periods when stocks are taking a dive.  Their motto is "Buy high and sell low," but you don't have to follow it.  Instead, you need a plan.

This introductory material hopefully will lay the groundwork for a lifetime of investing.

Bonds

The Pros and Cons of some Basic Investments

Bonds

A bond is a glorified IOU. 

When you buy a bond, you're simply making a loan. 

The seller of the bond, also called the issuer, is borrowing your money, and the bond itself is proof that the issuer, is borrowing.

The biggest seller of bonds in the world is Uncle Sam.  Whenever the US government needs extra cash (which these days is all the time), it prints up a new batch.

The government owes so much to so many that more than 15% of all the federal taxes goes to paying the interest.

The type of bond that young people are most likely to get involved in is the US Savings Bond.  Grandparents are famous for giving savings bonds as gifts to their grandchildren.  Over the years, the government pays back the money, plus interest - not to the grandparents, but to the grandchildren.

State and local governments also sell bonds to raise cash. So do hospitals, and airports, school districts and sports stadiums, public agencies of all kinds, and thousands of companies.  Bonds are in abundant supply. 

The main difference between bonds and CDs or Treasury bills is that with CDs and Treasuries, you get paid back sooner (the period varies from a few months to a couple of years), and with bonds you get paid back later (you might have to wait five years, ten years, or as long as thirty years).

The longer it takes for bonds to pay off, the greater the risk that inflation will eat up the value of your money before you get it back.  That's why bonds pay a higher rate of interest than the short-term alternatives, such as CDs, savings accounts, or the money market.  Investors demand to be rewarded for taking the greater risk.

All else being equal, a 30-year bond pays more interest than a 10-year bond, which in turn pays more interest than a 5-year bond, and so on.  The buyers of bonds have to decide how far out they want to go, and whether the extra money they make in interest, on say, a 30-year bond is worth the risk of having their money tied up for that long.  These are difficult decisons.

Stocks are riskier than bonds, and potentially far more rewarding. 

The good thing about a bond is that even though you miss the gain when the stock goes up, you also miss the loss when the stock goes down. 

That's why a bond is less risky than a stock.  There's a guarantee attached to it.  When you buy a bond, you know in advance exactly how much you will be getting in interest payments, and you won't lie awake nights worrying where the stock price is headed.  Your investment is protected, at least more protected than when you buy a stock.

Still, there are 3 ways you can get hurt by a bond.

1.  The first danger occurs if you sell the bond before the due date, when the issuer of the bond must repay you in full.  By selling early, you take your chances in the bond market, where the prices of bonds go up and down daily, the same as stocks.  So, if you get out of a bond prematurely, you might get less than you paid for it.

2.  The second danger occurs when the issuer of the bond goes bankrupt and can't pay you back.  The chances of this happening depend on who is doing the issuing.  The US government, for example, will never go bankrupt - it can print more money whenever it wants.  Other issuers can't always offer such a guarantee.  If they go bankrupt, the owners of the bonds can lose a lot of money.  Usually, they get something back, but not the entire investment.  And sometimes, they lose the whole amount.

When an issuer of a bond fails to make the required payments, it's called a default.  To avoid getting caught in one, smart bond buyers review the financial condition of the issuer fo a bond before they consider buying it.  Some bonds are insured, which is another way the payments can be guaranteed.  Also, there are agencies that give safety ratings to bonds, so potential buyers know in advance which ones are risky and which aren't.  A strong company gets a high safety rating - the chance of defauting on a bond are close to zero.  A weaker company that has trouble paying its bills will get a low rating.  You've heard of junk bonds?  These are the bonds that get the lowest ratings of all.

When you buy a junk bond, you're taking a bigger risk that you won't get your money back.  That's why junk bonds pay a higher rate of interest than other bonds - the investors are rewarded for taking the extra risk.

Except with the junkiest of junk bonds, defaults are few and far between.

3.  The third and biggest risk in owning a bond is:  INFLATION.  With stocks, over the very long term, you can keep up with inflation and make a decent profit to boot.  With bonds, you can't.

Houses or Apartments

The Pros and Cons of some Basic Investments

Houses or Apartments

Buying a house or an apartment is the most profitable purchase most people ever made. 

A house has 2 big advantages over other types of investments:

• You can live in it while you wait for the price to go up, and
• You buy it on borrowed money.

Houses have a habit of increasing in value at the same rate as inflation.  On that score, you're breaking even.

But you don't pay for the house all at once.  Typically, you pay 20% up front (the down payment), and a bank lends you the other 80% (the mortgage).  You pay interest on this mortgage for as long as it takes you to pay back the loan.  That could be as long as 15 or 30 years, depending on the deal you make with the bank.

Meanwhile, you're living in a house, and you won't get scared out of it by a bad housing market, the way you might get scared out of stocks when the stock market has a crash or a correction. 

As long as you stay there, the house increses in value, but you aren't paying any taxes on the gains.  And once in your lifetime, the government gives you a tax break when you do sell the house.

Some mathematics

If you buy a $100,000 house that increases in value by 3% a year, after the first year it will be worth $3,000 more than what you paid for it.

At first glance, you'd say that's a 3% return, the same as you might get from a savings account. 

But here is the secret, that makes the house such a great investment.  Of the $100,000 it takes to buy the house, only $20,000 comes out of your pocket.  So, at the end of year one, you've got a $3,000 profit on an investment of $20,000.  Instead, of a 3% return, the house is giving you a 15% return.

Along the way, of course, you have to pay the interest on the mortgage, but you get a tax break for that, and as you pay off the mortgage, you're increasing your investment in the house.  This is a form of savings that people often don't think about.

Fifteen years up the road, if you've got a fifteen-year mortgage and you stay in the house that long, the mortgage is paid off, and the house you bought for $100,000 is worth $155,797, thanks to the annual 3% increase in price.

Short-term investments: Savings Accounts, Money-Market Funds, Treasury Bills and Certificate of Deposits

The Pros and Cons of some Basic Investments

Savings Accounts, Money-Market Funds, Treasury Bills and Certificate of Deposits

All of the above are known as short-term investments.

They pay you interest.  You get your money back in a relatively short time.

In savings accounts, Treasury bills, and CDs, your money is insured against losses, so you're guaranteed to get it back.

Money markets lack the guarantee, bu the chances of losing money in a money market are remote.

One big disadvantage:  They pay you a low rate of interest.

Sometimes, the interest rate you get in a money-market account or a savings account can't even keep up with inflation.  Looking at it that way, a savings account may be a losing proposition.

Inflation is a fancy way of saying that prices of things are going up.  Another way to look at inflation is that the buying power of the dollar is going down.

The first goal of saving and investing is to keep ahead of inflation.  Your money's on a threadmill that's constantly going backward.  In recent years, you had to make 3 % on your investments just to stay even.

That's the problem with leaving money in a bank or a savings and loan.  The money is safe in the short run, because it's insured against loss, but in the long run, it is likely to lose ground against taxes and inflation. 

Here's a tip - when the inflation rate is higher than the interest rate you're getting from a CD, Treasury bill, money-market account, or savings account, you're investing in a lost cause.

• Savings accounts are great places to park money so you can get at it quickly, whenever you need to pay bills. 
• They are great places to store cash until you've got a big enough pile to invest elsewhere. 
• But over long periods of time, they won't do you much good.

Invest Now! What are you waiting for?

Many people wait until they are in their thirties, fourties, and fifties to start saving money.

The trouble is, by the time they realize they ought to be investing, they've lost valuable years when stocks could have been working in their favour.

One of the best way to avoid this fate is to begin saving money as early as possible, while you're living at home.  When else are your expenses going to be this low?  You have no children to feed - your parents are probably feeding you.

Money is a great friend, once you send it off to work.  It puts extra cash in your pocket without your having to lift a finger.

If you invest $500 a year in stocks instead of putting it in the bank, the money gets a chance to do you an even bigger favour, while you're off someplace living your life.  On average, you will double your money every 7 or 8 years if you leave it in stocks. 

A lot of smart investors have learned to take advantage of this.  They realise that capital (money) is as important to their future as their own jobs (labour).

Warren Buffett, America's second richest man, got there by saving money and later putting it into stocks.  To him, a $400 TV set he saw in the store wasn't really a $400 purchase.  He always thought about how much that $400 would be worth twenty years later, if he invested it instead of spending it.  This sort of thinking kept him from wasting his money on items he didn't need.

If you start saving and investing early enough, you'll get to the point where your money is supporting you.  This is what most people hope for, a chance to have financial independence where they're free to go places and do what they want, while their money stays home and goes to work.  But it will never happen unless you get in the habit of saving and investing and putting aside a certain amount every month, at a young age.

In the past people felt great pride when they worked hard and made certain sacrifices in order to pay for something all at once.  It made them nervous to owe money to the banks, and when they paid off their home mortgages, they had parties and invited all the neighbours to help them celebrate.

It wasn't until the 1960s that Americans got into the habit of using credit cards, and it wasn't until the 1980s that average families were hocked to the limit on mortgages, car loans, home equity loans, and the unpaid balances on their cards.

It is OK to pay interest on a house or an apartment, which will increase in value, but not on cars, appliances, clothes, or TV sets, which are worth less and less as you use them.

Debt is saving  in reverse.  The more it builds up, the worse off you are.  We see this in households across America, people struggling to make the payments, and in the government itself, which at the moment is hopelessly in debt.

America was once a nation of savers.

People of all income levels put aside as much money as they could, mostly in savings accounts at the local bank.  They made money on this money as it grew with interest, so eventually they could use it for a down payment on a house, or  to buy things, or to draw on in family emergencies.  In the meantime, the bank could take people's savings and lend them out to home buyers, or home builders, or businesses of all kinds.

Save as much as you can!  YOU'll be helping yourself and helping the country.

The Typical Shareholder of US stockmarket (historical data)

Since the 1950s, there has been a gradual increase in the number of people buying shares.  This is a positive trend, because the more shoreholders there are, the more the wealth gets spread around.

Twenty years after the Great Depression, the vast majority of Americans were afraid of stocks and kept their money in the bank, where they thought it was safe.  You've heard the expression, "I'd rather be safe than sorry"? 

• In this case, the money was safe and the people were sorry, because they missed the fabulous bull market in stocks during the 1950s. 
• There were only 6.5 million shareholders in 1952, only 4.2% of the population, and 80% of those shares were in the hands of 1.6% of the population. 
• All the gains went to a small group of people who weren't afraid of stocks and understood the benefits far outweighed the risks.

1962
17 million Americans owned stocks. 10% of US population.
The more stock prices rose, the more people jumped on the bandwagon.


1970
By 1970, there were 30 million shareholders in America, 15% of the population.
The eager buyers had pushed prices to dangerously high levels.
Most stocks were fatally overpriced.
Market corrected. 
So many brutal sellers during the brutal stock-market correction of the early 1970s.
5 million former shareholders, 3% of the US population exited the market en masse.

1975
It took 5 years for enough people to come back to stocks so that once again, the US had 30 million shareholders.

mid 1980s
47 million shareholders in US
1 out of 5 Americans owned stocks
33% of these invested through mutual funds.
Market value of all stocks on NYSE > $1 trillion

1990
51.4 million shareholders
A larger number of people invested through mutual funds. 
The average investor was no longer interested in picking his or her own stocks. 
The job was turned over to the professional fund managers at the nearly 4000 funds in existence at the time.
3.7 million shareholders or 7% of total, under the age of 21.

1995
Market value of all the stocks of NYSE > $5 trillion mark (In 1980, these same stocks were worth $1.2 trillion)
The money invested away in stocks had made the investors at least $4 trillion richer in a decade and a half.
That is letting your money do the work!


The typical shareholder in 1900
45 year old man
Annual income:  $46,400
Owned:  $13,500 worth of stocks

44 year old woman
Annual income:  $39,000
Owned:  $7,200 worth of stocks

Neither Buying at High Price nor Selling at Low Price.

The eager buyers of shares pushed prices to dangerously high levels, so by 1970, most stocks were fatally overpriced.  By almost any measure, people were paying far too much for the companies they were buying. 

This sort of craziness happens a few times in a century, and whenever it does, the market "correct," the prices drop to more sensible levels, and the people who bought at the top are stunned and depressed.  They can't believe they've lost so much money so quickly.

Of course, they haven't really lost anything unless they sell their shares, but many investors do just that.  They dump their entire portfolio in a panic.  A stock they acquired for $100 when it was overpriced, they unload a few weeks later for $70 or $60, at a bargain price.

Their loss is the new buyers' gain, because the new buyers will make the money the sellers woulod have made if they'd held on to their investments and waited out the correction.

The Importance of Saving, Investing and Acquiring Financial Education Early

A Beginner's Guide to the Basics fo Investing and Business. Why save and invest early?

The junior high schools and high schools of America have forgotten to teach one of the most important course of all.  Investing.

What's often left out is

• how saving money from an early age is the key to future prosperity,
• how investing that money in stocks is the best move a person can make, next to owning a house, and
• how the earlier you start saving and investing in stocks, the better you'll do in the long run.

We are taught little about the millions of businesses, large and small, that are the key to our prosperity and our strength as a nation.  Without investors to provide the money to start new companies that hire new workers, or to help older companies grow bigger, become more efficient, and pay higher wages, the world as we  know it would collapse and there'd be no jobs for anybody, and the United States would be out of luck.

In our own schools, we don't teach the basics of how this economic system works, and what's good about it, and how you can take advantage of it by becoming an investor.

Investing is fun.  It's interesting. 

• Learning about it can be an enriching experience, in more ways than one. 
• It can put you on the road to prosperity for the rest of your life, yet most people don't begin to get the hang of investing until they reach middle age, when their eyes start to go bad and their waistlines expand. 
• Then they discover the advantages of owning stocks, and they wish they'd known about them earlier.

There is nothing about investing that a woman can't do as well as a man.  Also, when you hear somebody say, "He is a natural-born investor,' don't believe it.  The natural-born investor is a myth.

The principles of finance are simple and easily grasped.  Principle number one is that savings equal investment. 

• Money that you keep in a piggy bank or a cookie jar doesn't count as an investment, but any time you put money in the bank, or buy a savings bond, or buy stock in a company, you're investing. 
• Somebody else will take that money and use it to build new stores, new houses, or new factories, which creates jobs. 
• More jobs means more paychecks for more workers. 
• If those workers can manage to set aside some fo their earnings to save and invest, the whole process begins all over again.

It's the same story for every family, every company, every country. 

• Whether it's Belgium or Botswana, China or Chile, Mozambique or Mexico, General Motors or General Electric, your family or mine, those who save and invest for the future will be more prosperous in the future than those who run out and spend all the money they get their hands on. 
• Why is the United States such a rich country?  At one point, we had one of the highest saving rates in the world.

A lot of people must have told you by now that it is important to get a good education, so you can find a promising career that pays you a decent wage.  But they may not have told you that in the long run, it's not just how much money you make that will determine your future prosperity.  It is how much of that money you put to work by saving it and investing it.

The best time to get started investing is when you're young. 

• The more time you have to let your investments grow, the bigger the fortune you'll end up with.  But this introduction to finance is not only for the young people.  It's for beginning investors of all ages who find stocks confusing and who haven't yet had the chance to learn the basics.

People are living much longer than they used to, which means they'll be paying bills for a lot longer than they used to.

•  If a couple makes it to 65, there's a good chance they'll make it to 85, and
• if they make it to 85, there's a decent chance one of them will reach 95. 

In order to cover their living expenses, they'll need extra money, and the surest way to get it is by investing.

It is not too late to start investing at age 65.  Today's 65 year olds might be looking at 25 more years during which their money can continue to grow, to give them the wherewithal to pay the 25 years' worth of extra bills.

When you're 15 or 20, it's hard to imagine the day will come when you'll turn 65, but if you get in the habit of saving and investing, by then your money will have been working in your favour for 50 years.  50 years of putting money away will produce astonishing results, even if you only put away a small amount at a time. 

The more you invest the better off you'll be, and the nation will be better off as well, because your money will help create new businesses and more jobs.


Ref:

Preface
Learn ot Earn
by Peter Lynch and John Rothchild
A Beginner's Guide to the Basics of Investing and Business

Basics of investing should be taught in school.

Many investors, including some with substantial portfolios, have only the sketchiest idea of how the stock market works.  The reason, is that the basics of investing - the fundamentals of our economic systema dn what they have to do with the stock market - aren't taught in school.  At a time when individuals have to make important decisions about saving for college and retirement funds, this failure to provide a basic education in investing can have tragic consequences.

For those who know what to look for, investment opportunities are everywhere.  The average high school student is familiar with Nike, Reebok, McDonald's, the Gap, and the Body Shop.  Nearly every teenager in America drinks Coke or Pepsi, but only a very few own shares in either company or even understand how to buy them.  Every student studies American history, but few realize that the US was settled by European colonists financed by public companies in England and Holland - and the basic principles behind public companies haven't changed in more than three hundred years.


Ref: 
Learn to Earn
by Lynch and Rothchild

In this book, the authors explain in a style accessible to anyone who is high school age or older how to read a stock table in the daily newspaper, how to understand a company's annual report, and why everyone should pay attention ot the stock market.  They explain not only how to invest but also how to think like an investor.

Will Your Stock Hit Rock Bottom?

Will Your Stock Hit Rock Bottom?

By Jordan DiPietro
January 22, 2010

Figuring out what you believe to be the intrinsic value of a stock is one of the most significant things you can do. If you bought shares of Sprint Nextel (NYSE: S) for more than $10 a pop, you better know at what price you'd be willing to sell, or you may find your stock hitting rock bottom.

How you define the floor
When investors try to determine a sales price, it seems as though we all too often let our emotions get the best of us. To illustrate this point, consider an experiment documented by behavioral economist and professor Dan Ariely.

Duke students are fanatical about their basketball program, and they illustrate their passion when it comes to buying tickets. There is a strict procedure where students have to camp out intermittently for an entire semester, responding to arbitrary bull horns and missing classes and exams. These are die-hard fans. For big games, students at the front of the line aren't even guaranteed a ticket -- only a spot in a lottery system. A list is posted later with the winners of the lottery, and often those who have sacrificed the most find themselves without a ticket to the game.

Duke professors wanted to conduct an experiment, so they found students who received lottery tickets and those who did not, and tried to find an equilibrium price where a ticket could be bought and sold. Remember -- both sets of students missed classes, spent evenings in tents, and went through the same rigorous process to obtain these cherished tickets. When the lottery losers were asked how much they would pay for a ticket, the average price was $175. The lottery recipients, on the other hand, would not sell their tickets for anything less than an average of $2,400! How could there be such a price discrepancy when both sets of students were willing to go through the same ordeal?

We all love what we have ...
The reason is that the lottery winners were victims of ownership bias; that is, they overvalued what they owned, simply because they owned it!

• This helps explain why people may have held on to shares of Cisco Systems (Nasdaq: CSCO) or Yahoo! (Nasdaq: YHOO), even when the dot.com bubble was bursting at the seams.
• Or why people were still holding onto financials like Bank of America (NYSE: BAC) in 2007, when the subprime crisis was all but written on the wall.

When investors make a purchase, what Ariely calls an emotional chasm is formed between the "old you" who didn't own the stock and the "new you" who now owns some very precious shares. In the case of Duke basketball, it was an "empirical chasm as well -- the average selling price (about $2,400) was separated by a factor of about 14 from the average buyer's offer (about $175)," Ariely wrote in his book Predictably Irrational.

I fall prey to this bias every time I buy a stock.

• In August of last year, I purchased shares of General Electric (NYSE: GE) when it was trading for about $11 and change.
• Because there is constant controversy surrounding a conglomerate like GE, I find myself ignoring criticisms of the company or critiques about GE's capital division -- just because I own the stock.
• I constantly have to remind myself to step back, impartially evaluate the company, and reassess my prospects for the industry.
• The stock eventually fell as low as $6 (though it has since recovered to $16).

And we never want to let it go ...
Say you were bullish on the solar industry and owned shares of First Solar (Nasdaq: FSLR) and Suntech Power (NYSE: STP), and analysts were coming out with negative industry reports. Instead of listening to the scrutiny and reading the reports, many investors would simply ignore the contrary opinion and convince themselves that their original analysis was correct. Because if in fact the analysts were correct -- and the solar industry was doomed -- then you'd have to sell your shares, and we've already established how we feel about things we already own. We simply don't like to let things go, whether it's a basketball ticket or a share of stock.

Do you know when to hold or sell that stock, because -- let's face it -- conditions change?

Remember, there's no greater way to avoid having your stock hit rock bottom than having received objective analysis and reasonable advice.

http://www.fool.com/investing/general/2010/01/22/will-your-stock-hit-rock-bottom.aspx

Tendency towards Volatility - Always Think about the Crowd!

Both fundamental and technical analysis can be helpful to investors in deciding when it is a good idea to buy or sell. 

Fundamentals generally change fairly slowly - over a period of quarters or years. 

Technical analysis are used by some as guide to profitable action in the nearer term. 

Prices tend to overshoot both too high and then too low in their attempts to reflect proper reality.

This tendency towards volatility, which seems to have increased in the age of trading at the speed of the internet, can either hurt you or help you.

How it affects us is driven by how well or badly we understand and handle price volatility.

This is a simple realization: that crowd behaviour frequently drives unsustainable and extreme price behaviour at tops and bottoms.

It follows from that observation that extra net returns can be earned by those who constantly watch for the crowd and who think of the market not from their own viewpoints alone but rather in terms of what the crowd is thinking.

Crowd size can be readily observed in trading volume and , with some lag, in net money flows to/from equity mutual funds.

Standing back and discerning where the crowd's often collectively muddled head is will always help you make a better decision.

What drives prices to change?

In the long run, yes, definitely the fundamentals or value.

But between now and that distant tomorrow, the answer is supply and demand. 

And the balance of those forces is not always rationally based.

It is at market-negotiated prices, not values, where we sell (and buy) stocks. 

And markets reflect people, not fundamentals alone!

It is not the news itself that moves prices, but instead the response of investors and traders to that news. 

To the degree that news constitutes a surprise, price will move dramatically.

The extent of changes in opinion can be measured in trading volume.  That tells us the degree of surprise hitting the market and the urgency with which the affected traderss and investors feel they need to take action. 

What studying volume does, in effect , is to reveal

• what the crowd is thinking and
• how big that crowd is. 

Understanding the crowd's collective mind set is crucial to being on the right side of the price action. 

Watching the crowd and the trading volume it creates will add a new dimension to your market and stock analysis.

Why Selling feels Uncomfortable?

Selling requires of us a significant change in our thinking - indeed a complete reversal! 

When we bought that stock, its prospects were wonderful, and it represented value and opportunity.  Now, whether our investment has since done well or not, to sell requires closing down hope and perhaps admitting defeat.  And it is possible that our defeat may have been created by faulty initial thinking, meaning we can place no blame externally since we were actually wrong all along.  Not a realiszation we savour.

Buying involves the opening o f possibilities of great things.  Buying represents open-endedness; continued holding maintains such hope for gain and pleasure (or, when we have a paper loss, hope for recovery and the righting of a temporary wrong).  Selling carries a finality with it because, by definition, it closes the book or ends the game and establishes a final score.  We prefer to have our options open rather than foreclosed, to retain chances for improvement and betterment rather than to know that the verdict is sealed and no chance for change exists.  We have great difficulty coming to closure since it cuts off further possibiiities; it ends hope for any better outcome.  Closure includes such experiences as

• cleaning out great grandmother's attic;
• graduating and leaving school and friends;
• acknowledging a failed marriage by concluding a divorce;
• burying a dear friend or loved one;
• seeing winter come;
• leaving an employer and valued colleagues;
• retiring and therefore wrapping up business. 

Those are heavy and sad passages, so we are predisposed to resist voluntarily creating any closure expereinces that we have power to avoid.  Holding does exactly that.

Holding keeps our options open, while selling clearly brings closure and finality.  (With surprising myopia, we ignore the fact that once we sell a stock we can just as easily repurchase it.  Viewing repurchase as a very real antidote to our revulsion against closure, however, raise visions of again going through that agonising process of reversing our opinion by 180 degrees, which is painful for all the reasons noted above.) 

• So we hold rather than sell because, at the very least, holding postpones coming to closure. 
• Many a bad stock is held (into an uncertain yet not hopeless future) with palpable likelihood of further financial loss because the (presently avoidable) emotional cost of coming to closure is perceived as so heavy. 
• Investors pay in dollar losses to avoid emotional pain from a closure process; often, as losses get worse, they will later need to pay a higher price in both lost dollars and eventual pain by imposing self-punishement over major mistakes. 

The closure aspect of selling is a powerful deterrent, one requiring both strong will and courage to overcome.

Why Holding Feels Right - Understanding the Psychology underlying this

Understanding the subtle but strong psychological impediments against selling

At a most obvious level, making profit represents pleasure, while suffering a loss equates to feeling pain.

Let us attempt to understand the deeper layer of forces that dispose us to certain attitudes and behaviours springing from our subconscious pain-avoidance and comfort-seeking tendencies.

When we own a particular stock, inaction (holding) keeps us in or certainly closer to a place of comfort than does taking action to change our circumstances (selling).  Holding onto a friend keeps us close to our past, to memories and feelings we cherish.  Many continue to hold stock in companies whose fortunes peaked years or even decades ago.  Logic alone cannot seem to explain why they resist selling despite obviously dim prospects for recovery or gain. 

• Maybe grandfather worked for the company, or we reside in a town where it supported many families or sponsored the softball team. 
• Perhaps ages ago we made a profit, or at least had a good paper profit for a while in this stock. 
• Or our parents always spoke well of the company or
• confided they had made a decent sum in its shares at one time. 

Thus, nostalgic positive feelings surround it and we find it very difficult to end our association.

Our positive associations with a particular stock create a bonded feeling. 

• We have made a good profit on an overall basis and while the annualised return may be unspectacular, a gain is surely better than a loss and the total dollar or point profit feels pleasant.  So this stock is our friend. 
• Held for a number of years now, it has been virtually adopted as a family member.  Thus, our primary inclination is to not severe such ties by terminating this comfortable relationship. 

Why end this thing, we think at an unconscious and perhaps also at a conscious level.  Living with, rather than without, that stock represents staying in a comfort zone.

Even though the company's fortunes may now have faltered, choosing to sell its stock represents adopting a 180-degree opposite stance.  Issuing that order to liquidate means that we once thought was correct now is no longer so in our minds. 

• This company is no longer under priced, or its prospects or management quality are not what we earlier imagined or expected. 
• Or perhaps we have given up on its price/earnings ratio growing as we had earlier envisioned.

To say sell means that either

• what we once thought was right is no longer so and/or
• that maybe we have already been on the wrong side of the market for some time and are now admitting a change in opinion is warranted. 

Either way, selling represents admitting we now believe what we earlier thought is no longer true.  Most of us have great difficulty acknowledging that we were wrong. 

If you place a very strong value on reputation or esteem in life, the reversal of position inherent in selling is likely to be an especially difficult battle zone for your ego and your comfort.  This can be a special problem for professionals such as doctors, attorneys, and others looked up to.  Reversing a position is made even more difficult if we have publicly or strongly espoused it.  This is a very important reason for keeping our investment holdings secret:  reversing ourselves and selling then at least involves no loss of face with others who knew our prior opinion.

Breakdown of Risk

Actions/risk
that affect only
------One firm-----Few firms---------Many firms---All investments--
                                
Firm-specific=1====2===3==========4=======5===Marketwide


1.  Projects may do better or worse than expected.
2.  Competition may be stronger or weaker than anticipated.
3.  Entire sector may be affected by action.
4.  Exchange rates and political risks affect many stocks.
5.  Interest rates, inflation, and news about economy affect all stocks.

The most prudent practice is never waiting to hear sell advice

A recommendation by an analyst to buy can be presented to every client interested in income.

A sale advice by an analyst applies only to those clients who already own the stock (and to that tiny minority oriented to short selling). 

A sale recommendation has a much smaller business-generating potential.  Reseach analysts are employed and compensated on the basis of the accuracy of judgement and on the amount of business their reports generate.  So analysts have a buy bias too.

Individual brokers face yet another dilemma when making a sale recommendation.  The investor tends to blame poor results more on a sale than on a buy.  That tendency can get brokers into trouble with their clients (and analysts into trouble with a firm's brokers).  Another way for a broker to get into even more trouble is to suggest redeploying the funds in another stock that goes down.

In summary, there are five ways a sale advice can backfire on a broker:

1.  It can offend the client who is emotionally attached to this stock.

2.  Selling can close out a painful transaction (a loss).
3.  The sale can be followed by a price rally, which would have provided greater profit or a reduced loss if the stock had been held.
4.  Funds liberated by the sale might be reinvested unprofitably, making the sale a double troublemaker.
5.  Unless the sale price proves nearly perfect, the broker is resented for generating a commission by suggesting the action.

It is also worth noting that penny-stock houses never recommend a sell unless it is to generate funds to buy something else.  The major reason is that they themselves must buy what investors sell because they, virtually alone, make the market in the stock. 

The most prudent practice is never waiting to hear sell advice.  Assume it will not be heard, and plan to make your personal selling-versus-holding decisions based on your own rules.

Euphemisms

Other words for sell, however, commonly do appear.  Brokerage firms have devised a variety of ways to describte a corporate situation that indicates a sale is the best option. 

• One of them is to write a report covering a corporate finance client, which is labelled a follow-up to the underwriting and carries no opinion or recommendation.  Follow-ups need to be read closely. 
• Even if the official policy is to give no recommendation, the tone of the report needs to be evaluated carefully.  If it is less glowing, suspect that the research analyst is not impressed with this stock and, while constrained from saying so, really thinks it should be sold. 
• Another way, short of uttering the Sell-word, is for the firm to drop analyst coverage of a company altogether.  Such silence is not golden.
• Another diplomatic approach is to give a recommendation other than buy that is kinder and gentler than the Sell-word itself.  The best euphemism for sell, ironically, is its operative opposite: hold.  When an analyst does not want to say buy and is not allowed to say sell, the only option remaining is hold.  Consider hold almost always as a danger sign.  In fact, hold really should generally be interpreted as meaning, do not hold.

Common brokerage euphemisms for sell:

• hold
• accumulate
• long-term buy
• market performer
• market weight
• perform in line
• under perform
• underweight

Another coded way of saying sell is a carefully worded message such as:  The stock is probably a worthwhile long-term holding despite some near-term uncertainties.  That is translated by teh cynic as:  If you hold for quite a while, maybe you will not lose.  All such euphemisms should be taken as signals to cash in.

On the other hand, don't place too much hope on an analyst's postings titled: "Why I like stock XXX a lot?"  Remember the analyst's buy bias and always to do your own homework.