I have been doing “Lessons Learnt as a Trader” series, but now since I have been investing, I should start a series for investing lessons so as to document and consolidate my learning journey.
Buy low and sell high
To make money, one has to buy low and sell high. This is a simple principle that people claimed to know but how many people really understand the meaning? When the market crashes badly, and stock prices are rock bottom, it would be the best time to buy stocks. But how many people have the courage to buy? When market is rising and they see their peers making money, they have the impulse to buy and join the “winning” crowd even though the stock price has risen a lot. In actual fact, people buy high, and sell low after the market crash. The key is to buy low, low enough that it is so difficult for the price to go lower, and much easier for the stock price to go up, making your portfolio profitable most of the time.
Supply and demand
In free markets, prices are determined by demand and supply, this goes the same for the stock market. The number of stocks remains more or less the same, unless the company issue bonus shares, rights issues, and share buybacks. We can only play around with this amount of stocks. The supply would refer to the sellers while the demand refers to the buyers. The demand and supply come from institutions, funds, traders, investors and retail investors, buying and selling with one another. Only when demand meets supply, a price is agreed and shares are being transacted. In a bull market, demand is high and drives up stock prices. There would also be less people wanting to sell. Higher stock prices would further induce more demand, and driving prices higher. It is until a point where demand dries up, there will only be supply (sellers). With more supply than demand, prices have to fall. Discerning the demand and supply in the stock market is key to timing the market. To buy low, demand must be low.
Patience
The problem with buying low is the ability to hold the stocks for a period of time. This can mean a few years without seeing any profits. You would have to wait until more people are interested in these shares and push up the prices. Do you have the patience to buy low and early? If not, selling the stocks prematurely would jeopardize your profits. Patience is also critical during a market correction. We know that even stock prices do not go up in a straight line during a bull run, they move 3 steps up and 2 steps down. You must also have the patience to hold through a correction. And when market is euphoric, you may be tempted to buy stocks since making money would be easy. But you have to remain rational and not buy any stocks in such market condition. In fact, you must look for signals to sell. Patiently stay in cash till the market crashes. As you can see, patience allows you to remain rational and do opposite to what most irrational investors do.
Posted in: Nature of Financial Markets
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