Why Chasing Bargains in the Stock Market Will Send You Broke.
When I first got involved in the markets, I adored the idea of writing (selling) puts. Why? Because it meant I could get paid money to tell someone I’d buy their shares at a bargain price. I love a bargain – the fact that I could actually get paid to snap up a bargain was just beyond my wildest dreams. Truly, the idea was so gorgeous that I promptly went and wrote a whole heap thinking I was the most amazing person in the world because I had discovered something simply incredible that was going to change my life.
And it did change my life. Absolutely. Mainly because I discovered put-writing in July 2008, and learnt very quickly that what looks like a bargain at one price actually is quite expensive three days later.
The Problem With Buying Cheap Stocks.
When people are first confronted by the stock market, they bring with them their ‘bargain’ mentality – buy low, sell high! It seems so perfectly obvious, and so damn simple! Buy a stock when it’s cheap, and sell it when it’s expensive.
The problem with buying low arises when you have to define what a ‘cheap’ share looks like. Unfortunately, it seems you can only know a cheap share in retrospect. A share might look cheap today, only to rudely prove the opposite tomorrow when it opens 50% cheaper. On the other hand, tomorrow it might be 50% higher in which case it would have, in fact, been cheap; but by then the boat is missed because that cheap share is now expensive. What a conundrum.
So we can’t buy a cheap share, unless we hold out our hand in the dark and are lucky enough to catch a falling knife. But assuming we do, in fact, get a hold of the slippery little sucker without drawing blood, we are now faced with our next problem – we need to sell high.
The Problem with Selling Stocks When They are Expensive.
How on earth can there be a problem with selling a stock when it’s expensive? In theory, there’s isn’t any problem with selling an expensive share. But in the markets, theory rarely plays out in real-time.
Pretend you have bought a share for the bargain price of $3.00, and find to your absolute delight it doubles in 3 months to an enormous $6.00. Time to sell, right? It’s doubled, it’s no longer cheap by any means and only a mad man would hang on. In fact, it’s a miracle you’ve hung on until now, because it was starting to look pretty pricey back at $4.50.
So you sell, pocket a 100% profit, tell your neighbours what a stud you are and start giving stock tips to your friends at parties. You’ve sold high, and life is good. But what happens when, 3 months down the track your disposed-of share is now trading at $12? Suddenly it turns out you’ve sold low. You sold when the share was cheap. Oh yes, the markets have ways of messing with us even when we think we’ve done well.
Price is not the Answer.
It’s all quite deceptive, really – I mean, they are called the markets, after all, and things are bought and sold there and not much else happens at all. So how can the markets not be about price, when price is all there is?
Here is my solution. The stock market is not the place for bargain hunting. It’s not a shop that has discounts. It’s not about value at all – it’s about price movement. It’s all in the moves. The trick is to discover just how you want the price action to look before you take the plunge and risk your cash.
This is by no means an easy thing to do. It can be extremely hard to buy a share that has just risen 30% from its lows, because we automatically tell ourselves that we missed a bargain. However, it’s vitally important to hear what that kind of price action is telling us. To me, that share is hollering that something very cool is going on. People are buying it – in fact way more people are buying it than selling it. And if there are more buyers than sellers, it’s gonna go up.
Now that is simple.