There’s an old adage when is comes to investment: “buy low and sell high.” It seems simple enough, and if it is done repeatedly and consistently it can produce a fortune. The problem is that is it really hard to do. It’s not difficult to do in terms of logistics. It’s not like the “sell” button in my trading account gets smaller and smaller as the share price of my stocks rise. Selling a winner is hard to do emotionally.
If you are anything like me, you like money. Making money makes me feel happy, excited, proud, smart, and powerful. Pretty strong stuff. Losing money makes me feel pretty much the exact opposite: sad, regretful, stupid, and irritable. Unfortunately, our brains are hard-wired to make us terrible traders. When we get rewarded for a behavior, such as when buying a stock makes us money, the parts of our brain responsible for the positive emotions we feel tell us that we need to do more of what we did the first time we felt these wonderful emotions. In this case, it is telling us we should buy more stock! This positive-reinforcement model works the same way that it does when you give your dog treats to train them to do a trick. If you want the dog to roll over and he licks his crotch, no treat. If he rolls over, treat. Then at some point, depending on how smart your dog is, he will start to realize, “Hey, every time I roll over, I get some treats! I’m gonna stop licking my crotch so much and start rolling over more!” The dog has become trained, or conditioned, through positive reinforcement.
But when it comes to the stock market, conditioning can be a very bad thing. When you make a good stock pick and the stock price rises, you get a “treat” for your behavior. And what are you supposed to do to make money over time? Sell??? Emotionally, you want more of those good feelings you got from buying the stock, and selling is a major buzz-kill. But if you never sell when the share price is high, you will never make any money.
It’s a tough pill to swallow, but the best approach to trading the market is to sell when you are having the most fun and buy when you are the most frustrated with the market. Everywhere I look, there are signs the economy is getting back on track. The talking heads on CNBC are claiming we are in the beginning of an extended secular bull market. The financial crisis is behind us, the S&P 500 is making new all-time highs on a daily basis, and the roads ahead look as clear as the sky is blue! Hopefully, the next few years will be smooth sailing for the stock market. As for me, I’ve spent the past year or so selling. I’m 40% cash at this point, and I plan on keeping it that way for the time being.
If you find my ideas about timing the market confusing, enlightening, or entertaining, look for my discussion of the investor sentiment cycle in my upcoming book. Details will be provided soon!