Editor’s note: This article was first published in May 2011, right after the financial crisis; its references to “the last two years”, “this past year” and “what will the market do in 2012?” reflect that moment.
I’d like to point to an article by a Rankia user, Hugo de Ferrer, titled “Why is a psychologist a better investor than an economist?” (in Spanish). It suggests something we have discussed several times before: for some time now, the stock market hasn’t followed any logic.
As Hugo de Ferrer rightly says, the fact that a share goes up or down by a single euro today has no economic explanation. Logically, the market should rise over the long term roughly in line with inflation, and if we take the last two years as our long term, it certainly hasn’t (although that fall, caused by the crisis, does have an economic explanation). What will the market do in 2012? Nobody can know. But if you keep track of the kind of shareholders and the earnings of the companies you’re investing in, to the point of knowing what those investors will do tomorrow (sell, buy or hold), you can foresee a share’s movement seven days out.
I don’t know what financial analysts, stock market analysts, financial advisers or economists are saying, and frankly I don’t care, because they haven’t got a single call right this past year.
Financial advisers take their clients on high-risk paths towards returns of 2-3% at best, and when they lead their clients into losses, out comes the slogan “Sometimes you lose in the stock market.” Bank investment funds that promise high returns hide the final outcome of the investment in the small print: you’re going to lose money, and if you do make something, the fees will “suck it dry.” Read also: “Investment funds: don’t let the bank rip you off.”
Advisers and market analysts give lectures at universities, recommending a diversified portfolio of eight stocks that ends up as three high-return stocks, two medium-return ones and another three whose losses eat up the gains of the other five.
And all this happens while, day after day, I watch people who are never invited to lectures to explain the stock market system that earns them high returns year after year. Of course, they couldn’t explain their system, because they don’t have one. The reality is that no system can guarantee success in stock market investing, because it isn’t a matter of economics but of investor psychology and plenty of common sense.
Today, if someone with no experience of the stock market picked an IBEX stock at random, they would stand a better chance of earning a higher return than a whole team of stock analysts designing an investment fund for a bank, and the evidence speaks for itself.
When you take a stock market course, the teachers (who usually aren’t investors) give you the economic explanation for why a stock rises or falls, teach you to read a chart and introduce terms such as GDP, P/E, lateral resistance, ceiling, floor… And nobody explains something that’s plain common sense: if one organisation holds 80% of a company’s shares, that stock won’t behave the same as one whose shareholders are 90% small investors. Clearly, the volatility of the two will be very different, because in the first case a single sell order could sink the share price within minutes.
The stock market is a game. You don’t need to know about the global economy, though you do need a minimum of business sense and to develop certain skills needed to play this game.
That said, as we’ve said before, the stock market isn’t as easy as it sometimes looks, nor as hard as some would have you believe. It does require a basic understanding, and you can acquire that outside a university.
Why do economists fail and private investors succeed?
Very simply, because an economist forgot years ago what the stock market is about. The stock market is a game as simple as buying at 2 to sell at 3, knowing full well that over time the share could reach 5. What you do need to be able to analyse is why that share is trading at 2 now and what reasons you have to think it could reach 5.
That’s why we always recommend analysing the company, its business plans, its market strategies and whether investors like it. Knowing that, you have a better chance of success than the people who switch on their four screens and fixate on those red, green and blue lines that, in the end, show past behaviour but not future behaviour.
That’s the reality, like it or not.
Note: so that nobody takes offence, we’re well aware that there are genuine professionals working as financial advisers with excellent results. Every profession has its exceptions.
Further reading
- Why stocks are the most profitable investment
- How you can go broke investing in the stock market
- Common mistakes when investing in the stock market
- The 7 levels of investors
Featured image: SimonP, CC BY-SA 3.0, via Wikimedia Commons.
