I’m often asked what I think are the most common, most ruinous mistakes that investors make. Unfortunately, there are a lot of them.
There are things such as risking too much money on a single trade or investment … not using protective stops … not using disciplined money management … trading too often … not doing your homework … taking on too big a position in any market … not diversifying enough … and so forth.
Over time, I will explore each and every one of the above in greater detail, and more, to help you learn how to become a better investor and trader.
But in today’s special column, I want to cover what I think is the most dangerous mistake investors make, bar none.
It’s having a set of preconceived notions
about what markets can and can’t do.
The fact of the matter is that markets can do whatever they want to do.
|If you don’t understand a market, it’s not the market’s fault; the fault lies with your analysis.|
Markets are never wrong. Markets are never irrational.
They are what they are. And if you don’t understand a market, it’s not the market’s fault; the fault lies instead with your analysis.
For instance, have you ever heard someone say “a market is defying all logic?”
Or that a market is “disconnected from its underlying fundamentals?”
I’m sure you have. I hear those kinds of phrases all the time on shows such as Bloomberg and CNBC, especially in the current environment where stocks keep moving higher and very few have a solid understanding of why.
Or where gold has crashed despite all the seemingly bullish fundamentals.
I see plenty of experts make such statements too. But the fact of the matter is that …
Markets NEVER defy logic.
And they never defy the fundamentals.
Only people defy logic. Only people can make such statements about fundamental forces as well, because when a market is allegedly defying fundamentals, what it’s really doing is operating on fundamental forces that the analyst or investor simply hasn’t figured out yet.
I fully realize that what I’m talking about here is hard to grasp at first. But if you take the time to think deep and hard about what I’m saying, you will elevate your trading and investing to a whole new level. Markets are never wrong. Only people are.
Especially dangerous for most traders and investors is
getting caught up in the various “market myths” that are out there.
For instance, how many times have you heard that rising interest rates are bad for the stock market, and that declining rates are good for stocks?
If you’re like the average investor, you’ve heard that theory literally hundreds, if not thousands, of times before. Tune into any media show today, and I’m sure you’ll hear it at least once, if not more.
Most stock brokers, and the majority of analysts and newsletter editors espouse the same causal relationship between interest rates and stock prices.
But the fact of the matter, the plain truth, is that there is no “standard relationship” between interest rates and stock prices. Period.
Consider the period from March 2000 to October 2002, where the Federal Funds rate declined from 5.85 percent to 1.75 percent, and the Nasdaq plunged 78 percent. Put simply, stocks and interest rates went down together! Exactly the opposite of what most would expect.
Or the period from March 2003 to October 2007, where the Federal Funds rate more than tripled and rose from 1.25 percent to 4.75 percent …
And the Dow exploded higher, launching from 7,992 to 13,930 — a 74.2 percent gain! Stocks and interest rates went higher together!
The fact of the matter is that the relationship between interest rates and stock prices varies considerably depending upon a host of factors, including the value of the dollar and where the economy is in terms of the economic cycle.
But the bottom line is this: Never assume anything and never, ever get caught up in conventional thought about a market or you will most likely lose your shirt.
Let’s look at another market myth. Almost everyone believes that gold and the dollar cannot go up together.
And so, they also believe that the dollar and gold can’t go down together.
But that’s completely inaccurate. There have been plenty of times when the dollar and gold have gone up together … and there have also been plenty of periods when they have gone down together.
In fact, in the not-too-distant future we are probably going to see another such period for gold, where it and the dollar go higher together.
In fact, when the European Union really disintegrates, which is not that far off, that’s probably exactly what we will see: A mad rush of European money into the dollar and into gold and out of the euro.
Yet most analysts and investors will probably be caught flat-footed. They’ll see the dollar soaring, and will get their clients and subscribers out of gold, at the worst possible time!
Or consider another big myth, that rising oil prices are bearish for stocks. That’s a bunch of mostly baloney too.
The fact of the matter is that there have been plenty of times when rising oil prices were bullish for stocks … and where falling oil and energy prices were bearish. Exactly the opposite of what most conventional thought tells you.
Or consider the normal view about a country’s widening trade deficit. The common theory is that a widening trade deficit is bad for stock prices and a narrowing deficit is good.
But history proves that it is entirely wrong, and nothing more than a myth.
Fact: From 1976 to 1998, the U.S. trade deficit ballooned from $6.08 billion to $166.14 billion, and guess what? The Dow Jones Industrials went from 848.63 to 9,343.64!
In truth, the relationship between the trade deficit or surplus and stock prices is exactly the opposite of what most pundits claim.
Or consider the myth about corporate earnings that says they have to rise for stock prices to continue higher. But from 1973 to 1975, the combined earnings of the S&P 500 companies rose strongly for six consecutive quarters, yet the S&P 500 Index fell more than 24 percent.
Moreover, according to research conducted by analyst Paul Kedrosky, since 1960, the average annual return on the S&P 500 was greatest when earnings were falling at a clip of 10 percent or more … while the smallest returns on the S&P 500 occurred when earnings were growing at up to 10 percent per annum!
In other words, rising corporate earnings does not guarantee rising stock prices, by any means. Nor does falling corporate earnings guarantee falling stock prices!
Here’s another myth that drives me nuts …
Most advisors and investors will tell you that lower-priced stocks — I’m talking say, less than $10 — are risky and not solid companies to invest in.
But that’s total baloney. Heck, if you had invested just $5,000 in Microsoft (MSFT) when it was just $2 a share, you’d have $82,475 today. Or $5,000 in Apple (AAPL) in 1997 and it’s worth a whopping $706,428 today.
There are many myths or biases out there about the relationships between economic fundamentals and markets, about stocks, or between markets and other markets.
But the fact of the matter is that almost all of them are exactly that: Myths, and nothing more.
The bottom line: To avoid making the biggest investing and trading blunders …
1. Never assume anything when it comes to the markets …
2. Question everything, and most of all …
3. Think independently!
Stay tuned and best wishes,