As we go about our daily lives there are approximately 1.5 million* behaviours that are totally ingrained in us from childhood. These behaviours are perfectly acceptable and useful for functioning as a successful human, but on the flip side have the ability to destroy any hope we have of ever becoming a successful trader.
Not only do we have our emotional residual caveman instincts to deal with, we also have stuff from we learned Mum that we can most certainly blame for our lack of success.
The problem we can blame Mum for is to do with our perception of value. Like any self-respecting girl, I love love love a bargain. It seriously makes me happy, because not only did I buy the item I needed, I saved money in the process. I am a big fan of making money, and don’t care whether it’s money saved or money made, it’s all the same to me.
So how can I blame Mum for this? Well, she’s the one who took me shopping as a kid. She’s the one who told me I couldn’t have things because they were too expensive, and she’s the one who bought me clothes from Kmart because they were cheaper than designer. She taught me to shop responsibly, in other words.
When we shop, we have an idea of what we’re willing to pay, what represents good value and what is stupidly expensive.
Take bananas for example. I know they are usually about $4/kg, and I’m happy to pay that. If they’re on special for $2/kg, I’ll buy loads because my kids love them and they’re cheap.
But if the whole crop gets wiped out due to a cyclone and they’re now charging $13/kg, you can count on the fact we’ll be a banana-free zone until the price becomes reasonable again.
This value perception has the potential to totally screw you over in the market.
Our instinct tells us that if Stock X is buyable at its current price of $30, then it’s a bargain at $28 and we’d be mad not to buy more. Then, as it gets to $25 it’s an absolute steal, so we load up. It’d be a crime to not buy at this price, right?
Share X then proceeds to steadily fall to $7.50 where it happily remains extraordinarily cheap but for some reason no-one’s buying it. Odd, huh?
Or on the other hand, we could see our stock rise to $35. Woohoo!
So we sell it because it’s starting to look pretty expensive and no longer represents good value, so who in their right mind would buy it?
This picture is the complete opposite of the thinking required to trade successfully. Buying more as price falls, and grabbing a quick profit feels right – it’s perfectly in line with our upbringing, but it’s a recipe for disaster in the markets.
If we turn that process on its head we can see what we should actually be doing. We buy Share X at a price we think is appropriate, via our technical/fundamental/pot luck approach, and then what?
If it goes against us, we need to get out. There are no bargains here, and we definitely aren’t allowed to buy more.
But in the happy event price moves in our direction not only do we have to resist the impulse to net a quick profit, we have to grit our teeth and buy more. And more and more and more as the price rises – keeping an eye on our risk levels as we go.
A stock is never too “expensive”. If it’s going up, the market is telling you something. If it’s trading at new highs, the market is really yelling at you to pay attention.
Traders need to get over the idea that a stock is expensive or cheap and listen to what the price action is telling you.
Prices have the potential to go both higher and lower than we ever imagine possible, often well beyond any idea of value at all. We only have to look at the Dot.com boom to see just how crazy prices can go in a company of very questionable intrinsic value, and likewise strong companies can get sold off for seemingly no reason at all.
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