Forget About Conventional Wisdom
The following 10 Wall Street myths have been circulated throughout history. By knowing these, the novice can make better decisions than many of the so-called experts who help to perpetuate them.
Myth 1: The market always goes up longer term.
It seems to be universally preached that the market “always goes up longer term.” And all you have to do is buy a diversified mutual fund or index fund and wait. The problem is that markets do not always go up longer term. Well, it depends on what you mean by longer term.
Suppose you bought stocks in 1929 at the market peak. Provided you could have held through a 90 percent loss, it would then have taken you a quarter of a century just to get back to breakeven. Let’s say you bought stocks in the mid-1960’s. Your return would have been almost zero until the market finally broke out in 1983, 17 years later.
Some might be thinking “that was then, this is now.” Unfortunately, the bear market that began in late 2007 would turn out to be the worst since 1929. By March 2009, the S&P; was at 13-year lows. From these lows, the market will have to rally over 200 percent just to get back to breakeven.
The “buy and hold does not work argument” often invokes heated debates. Don’t believe it? Look at the charts 1, 2, and 3.
This brings us to our next myth.
Wall Street Myth 2: Technical analysis is mumbo jumbo
In its most basic form, technical analysis is simply the use of charts to help predict the market. Charts are used in every business yet many refuse to use them in stocks. There is nothing magical about each little daily bar. It simply reflects how the stock traded that day based on the buying and selling of the market’s participants. If a large institution makes a trade it becomes part of the chart. If a well-informed insider makes a trade, it becomes part of the chart. You may not know what these participants are going to do next, but you can plainly see exactly what they have done. From this, patterns will emerge. These patterns reflect the psychology of what they and others are likely to do next.
Wall Street Myth 3: Experts know exactly where the market is headed
Experts and “market gurus” will talk with total certainty. Think about it. In order to know with absolute certainty that a stock is headed higher, you’d have to know everything in the world. You’d have to know that the CEO is not going to drop dead of a heart attack , you’d have to know that he’s not going to get involved with a ex-porn star, fudge the books, or embezzle from the company. “It” happens. You’d have to know that:
- A hedge fund with a large holding in the company will not only continue to hold the stock, but will buy even more.
- There will not be any more terrorist attacks.
- The economy will remain strong.
- There will be no government intervention or change in laws that are currently favorable to the company.
The list goes on and on. The bottom line is, in order to predict with absolute certainty, you’d have to know everything.
Wall Street Myth 4: Good fundamentals make for good investments
Has this ever happened to you? You own a stock. The company announces great earnings. You are excited. You watch in horror as the stock drops sharply. So what happened? Evidently, Wall Street has discounted those earnings and was hoping for even better earnings. Actual fundamentals do not matter for trading. Of course, a company will eventually have to make a profit. Otherwise they will run out of money and have to close the doors. However, “eventually” can be a long time. Stocks can trend higher for months or even years as long as the hope for good fundamentals stays alive. In fact, some of the best performing stocks have the absolute worst fundamentals — at least for the periods where their performance was the best. Conversely, stocks with great fundamentals can trend lower for extended periods of time. At some point they might be perceived as a value and begin to trend higher, but there is no guarantee. In the meantime, the economy could worsen, their products could become obsolete, competitors can arise, or a bear market could come along. Fundamentals do not matter for trading. The perception of them does.
Wall Street Myth 5: Buy low and sell high
The old Wall Street adage “buy low and sell high” is universally preached. The problem is, no one knows what “low” is and if a stock is trading at low levels chances are that it has been trending lower and will continue to trend lower. Thousands of stocks that seemed “low” in bear market of 2008 were substantially lower by 2010. Some even went bankrupt including a brokerage established in 1850 and a bank founded in 1889. Attempting to buy low is a loser’s strategy. You’re actually much better off trading the trend by buying high and selling higher.
Wall Street Myth 6: Buy stocks that have a good dividend yield
High dividend yield stocks sound great on paper. You can buy the stock and get a double digit return on the dividend. Unfortunately, the reason the dividend is so high is because the price of the stock has dropped, thereby causes the dividend yield to rise. And if a stock is dropping, there’s probably something wrong with the company. What you make on the dividend will more than be offset by losses in the stock. Further, since something is obviously wrong, there’s a good chance that the company won’t be able to continue paying the dividend.
Wall Street Myth 7: You can’t go broke taking a profit
Taking profits is exactly how many people go broke on Wall Street. They sell small winners and hold on to losers. Just 1 or 2 loses will wipe out many if not all of the small gains. It’s human nature. Small winners are sold to keep them from becoming losers and losers are held because they refuse to give up. This brings us to our next myth.
Wall Street Myth 8: It is only a paper loss
There is no such thing as a paper loss. A loss is a loss. Many think that a loss is only a loss if you “take it” by exiting the stock. If you are losing big on a stock, you must exit. Yes, there is a chance that it will come back. But there is also a chance that it will not. What’s worse is that if a stock is dropping, chances are that it could be a trend. Therefore, there is a good chance that it will worsen. Your account balance is your account balance, regardless of whether you have positions on or not. You can’t show a creditor your account and explain to them that it is really worth another $100,000 because these stocks will come back and that these are only “paper losses.” A loss is a loss.
Wall Street Myth 9: There is a reason the market is going up or down
The media will tell you daily exactly why the market went up or down. They infer that there is always a direct reason as to why stocks rise and fall. By this logic, all you have to do is learn the correlations. However, more often than not, there is no reason why stocks rise or fall. They trade on emotions, period. Don’t confuse the issue with the facts.
Wall Street Myth 10: The market is always okay
Bad news might sell newspapers, but it will not get you a job as a television stock commentator. You do not want to turn on the financial news to hear that stocks are headed lower. You want to hear someone say that the worst is over and that you should hold on to your stocks because “they will come back.” It is okay to watch the financial news. Just remember that there is an upside bias even, and often especially, when the market is obviously doing poorly.