Stage 0

Say you have saved some money, but you are concerned that the interest from the bank can’t match the inflation. Plus, you hope to grow your asset so as to buy a house or a nice car later. And you’ve learned from someone that investing in the stock market can grow your asset quickly.

Stage 1

So you opened a brokerage account hoping to buy some stocks, but you don’t know what to buy. You often hear some experts on TV recommending some stocks as “buy” and some as “strong buy”. That’s very exciting, you think. So you bought some of the recommended. Elsewhere, you heard from your friends about some super stocks, and you also decided to follow suit on some.

Stage 1.1

So you watch your stocks closely everyday. Wow, today I make $460. I am going out for a good dinner! Wow, XYZ gained 2% today! I will be very rich soon. Oh, ABC lost 3%, come on! After a year, some made a bit of money and some lost, and your stock portfolio made you 2% overall. But that’s not much better than saving money in the bank. You are not too happy. But you decide to learn more.

Stage 2

You found some very low priced stocks at $1 or $2. When they grow to $100 or $200, these should make me a lot of money. So you sold your old stocks and bought some of these low priced ones. Well, these are indeed very exciting. SXYZ up 10% one day. Oh, why CVBG down 13% today? No worries, tomorrow it will get back up. But after 6 months, you lost 15% overall. 15%, that’s $3000! How am I going to tell my family about the loss?! You are very upset.

Stage 2.1

In the meantime, some of your friends were boasting about their wins: “my DFGH has been up 32% since I bought, my JKHJ is up 26%”. Hearing this you felt more upset, but in order not to appear stupid to them, you told them: “my SXYZ was up 10% on the day I bought it”.

State 2.2

So you didn’t want to give up. Then you learned, those low-priced stocks are not famous companies. They are doomed to lose money, aren’t they? How could I make such stupid mistakes?!

Stage 3

So I should buy good and famous companies. Through some research, you found a few good companies whose stocks are down over 40% from the past. Well, these are great bargains! So you dumped all your low-price stocks and bought these good companies. Well, these are not as exciting. They don’t grow much everyday. After a month, you are down 3%, after 3 months, down 11%, after 6 months, down 18% and after a year, down 29%. But in the 8th month you made 4%. These are good companies and they will go up eventually, and I want to hold, you think. You can’t tell about the losses to you family, though you felt very sad, you told them that you made 4% in a month. After another 6 months, you are down 35% totally. So you said, that’s it, I am out! So you dumped all the stocks.

Stage 3.1

After 6 months, you somehow noticed some of those stocks you sold went up. You calculated your previous portfolio would be up 12% from the time you sold. You are surprised but believe that they will continue to go down soon. After another 6 months, they went up another 23%. You felt so upset about selling them. They’ve been up 35%, too risky to buy now anyhow. Forget it!

Stage 4

How did Warren Buffett make so much money buying stocks, you wondered. There got to be some secrets I don’t know. So you read a lot. Then you’ve learned about some measures like price-earning ratio, price-sales ratio, etc. Warren Buffett was looking at companies financials, so this got to be the essence. So you started to buy some stocks with low PE or PS ratios. But these turned out not exciting either. Not much movement in a day. After a year, your total portfolio was down 2%. What another disappointment!

Stage 5

Then you learned buying momentum stocks is a great way to make money. You dumped the low PE low PS stocks and started buying big movers. You now have a strategy: buy stocks that have gone up 10% in the past week and sell them when they go up another 10%. That sounds a great strategy because every time you would make 10%, so you can say bye-bye to losses. And that worked at least for the initial few stocks. You felt like a hero. But quite some stocks never reached the 10% profit line and even got to negative areas in quite a few months. So you hanged on to them. After a year, you are down 15%. Why couldn’t I make money?

Stage 5.1

Then you learned about cut your losses. So you decide to modify your strategy: buy stocks that went up 10% in the past week and sell them when they go up another 10% or when they go down 5%. That sounds also very good as you win 10% and lose 5% so on average you make 5%. Then you did that for a year and you are down 5%. Well, what a waste!

Stage 6

Then you learned about trend following and the wonderful indicator: moving averages. You did some analysis and found out buying XCDC when the price crosses up 17-day MA and selling it when it cross down the MA will allow you to increase your asset very quickly and avoid major losses. This must be the holy grail! After trading this for 3 months, you are surprised that the asset never grew as measured. You had some losses and some wins but your asset actually had some loss on average. You re-examined the past measures, and found indeed there are similar period in the past, so you take the performance as normal and continue to trade. Then after 6 months, you have a loss of 9%. What is wrong? You went back to do another analysis and it turned out using 19-day MA is better than 17-Day MA. So you changed the indicator and traded likewise. And then the performance is similar. What’s the problem?

Stage 6.1

Moving Average must not be a good indicator. Fortunately, there are many other indicators. So you went trying quite a few of them, in the end, no luck for getting a good performance.

What are wrong?

On Stage 1

Buying stocks based on other people’s recommendations is purely wrong. There are many issues with this. For a simple analogy, it’s like marrying someone simply based on other people’s recommendation. The recommender could be wrong. Or he may be right, but he has his own plan regarding the time frame, risk tolerance, profit expectations etc that are unknown to you. Or he may want to have these stocks in his portfolio to balance out some measures which you don’t know about. And so on.

On Stage 2

The dollar value of a stock has nothing to do with its potential worth. It’s true that low priced stocks tend to move faster (both up and down), particularly if they are low capitalization stocks. You can take a note of that nature and trade them accordingly with the right strategies. And, low-priced stocks are volatile but not necessarily doomed to lose money.

On Stage 3

Good companies are not necessarily good at the moment. They might have some business or financial trouble, which can be very well the reason why the stocks dropped from past highs. It might be good to buy them, but one has to thoroughly research about their business and pay attention to the timing. Of course it’s difficult for a market newbie to research about a business and grasp the time of stock changes, so these stocks are not good options.

On State 4

This may be in some way similar to Stage 3. PE ratio is calculated with the current price over earning of the past year. So if the company made much money last year but the market generally sees it having some trouble ahead, then the current price will be pressed down. Or, if the company is in a traditional business (like plumbing) that normally has very low earning grow year over year, then not many investors are interested in buying it, so the stock stays low. Now, there can be treasures among the low PE (or other similar measures) stocks to some sharp professionals like Warren Buffett, but they study them very thoroughly which again can be very hard to achieve by small investors.

On Stage 5

Chasing high movers can be good trades mainly during bull market. Knowing about cutting losses, grasping magnitudes, and managing time frames are very important. It’s not helpful to just plainly draft a strategy like buy at 10% gain and sell at 10% gain or 5% loss. One has to define a better strategy after doing enough testing.

On Stage 6

So one has advanced at this after enough experiences in trading. The indicators certainly appear promising to guide one’s trading. But the essence is that the market is a moving target. Every participant wants to make some money. When anyone sees some opportunity, he jumps quickly at it. If many people jumped on the same opportunity, the opportunity disappears (it doesn’t mean that they all use the same indicator, actually many indicators indicate similar things). As an analogy, if you sit on a boat with a group of people and you see the left side has a better view. So you move there. And at the same time, many other people also move to the left side, and the end result is the boat capsizes. Indicators can’t be used bluntly. If using an indicator, one has to have good understandings as to how many people use it and how they are using it etc. I might want to expand on this on a subsequent post. Until then,

Cheers! Santé! Prost!