It is a well-known fact that the markets are ruled by two
human emotions: Fear and Greed. I am going to show you why both these
emotions can cause you to make enormous mistakes in a stock market crash
and why you should prepare yourself now to avoid making them.
Incidentally, I am going to talk about a mistake that 85% of
people make in a market crash and one that I myself made in the year
2000 which caused me heavy losses. If you learn from this, you can avoid
financial suicide.
Remember: the wise man not only learns from his own mistakes, but from other people's mistakes…
THE DOT-COM DONKEYS
I will never forget January 2000 where I had my first taste
of dabbling in stocks. In case you don't remember, that year was also
the height of the dot-com bubble. Technology stocks were soaring through
the roof and greed had control of the market. Ordinary people from taxi
drivers, teachers and plumbers were drooling at the idea of making a
fortune in stocks.
I had been watching the stock of one particular company very
closely. Exodus Communications Inc (EXDS) had tripled in value from $20
to $60 in just two months. I was thinking to myself, wow what if this
stock now goes to $100, $200 – heck, all the way to the moon! How could I
miss such an opportunity! (see chart below)
I finally bought the EXDS at $65. Now all I had to do was
sit back and watch my trading account get fatter than a turkey before
thanksgiving. By March 2000 the stock was just under $90. I could not
believe my luck. "Good call!" I was saying to myself.
Very soon, my luck ran out. By April of that year EXDS was
at $50 and by May it was at $40. Then a voice inside my head said: "Hey,
why don't we buy some more – now they are cheaper!" I dug into all my
savings and I spent every last penny on buying even more of that stock.
After all, it was an "investment".
"Buy low, sell high", right? Isn't that what we have been taught?
Wrong. By May of 2001, a year later, the stock had plunged
to less than $10. This was an 85% drop from the original price I had
bought it at. Eventually, in September 2001, I was finally put out of my
misery: EXDS filed for bankruptcy.
FEAR AND GREED
There is no doubt about it. What I did in the year 2000 is
what "donkey" investors do – also referred to as “dumb money”. The smart
money was selling technology stocks and dumping them unto the small
guys. This is the way the markets have always worked and will always
work.
Two emotions were ruling the marketplace:
1) Greed: the desire to make money
2) Fear: The fear of missing out on a huge opportunity
Notice that this is a different kind of fear than the one
experienced by investors during a market crash: the fear of losing
money.
THE No.1 MISTAKE
What I want you to understand is that you must never buy a
stock (or commodity) simply because it is "cheap". That is not a good
enough reason to buy. What you are essentially doing is trying to catch a
falling knife! You are going to get hurt.
This mistake is often perpetuated by the misleading phrase:
"Buy low, sell high". This phrase is often misinterpreted for: "If it is
cheaper then buy it, and sell it when it gets more expensive". That is
total garbage.
You see, what most people don't realise is that when a stock (or commodity) is falling, the trend and momentum direction of that market may have changed.
To put it very simply: if a
stock is deliberately moving downwards and gaining momentum (or speed)
in that direction, and you try to stand in front of it (by buying the
stock), it will crush you. You do not stand in front of a freight train.
Here is a case example:
In 2008, friends were telling me they were buying Lloyds TSB
shares at £2.00 ($3 USD) because they thought it was a bargain. It was
not – that company's share price went all the way down to 50 pence!
Those shares have not recovered since then and at the time of writing
sit at 35 pence (see chart below):
LOSING TIME
I know what you may be thinking: "What if you waited a few
years for the price to recover – then at least you'll get your money
back and break even."
OK, let's say that you are lucky enough that your stock
recovers and in three years it has come back to the original price you
bought it at. You have your money back, well done. But you have lost
something you will never get back: Time. Three years!
During those three years you could have been shorting that
market (making money downwards – and more on that in upcoming posts), or
investing in stocks that were going up.
CONCLUSION
Be prepared. If we are indeed heading for another stock
market crash, and I believe we are, then you need to take control of
your emotions right now!
Stocks will get cheaper, and cheaper. If you listen to the
voices of greed inside your head saying to you: "Hey, at this price,
this stock is a bargain!" you are setting yourself for financial
suicide. For the bargain hunters, there is only one way their story will
end: in tears.
http://www.portiontv.com/the-most-important-mistake-you-will-make-in-a-falling-market.html
thanks to member jkljkl who educated us about "portiontv.com"