Many profound investors often state that you should not follow the investment public as collective opinion is mostly driven by fear and greed. Closer look at the Dow Jones ETF (DIA) gives the evidence that one should follow his own strategy and distance from the public mood no matter if there is joy or blood on the (Wall) street.
One of the most remarkable thoughts of Benjamin Graham on the issue: ”Most of the time stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble… to give way to hope, fear and greed.”
Mentioned by the famous investor behavior could be clearly seen on the Dow Jones 3 year chart. Examination of the last 4 corrections during past 3 years consistently shows the same outcome. Dow fluctuates around its long term trend – 200 day moving average which it is not surprise for anyone. However all corrections have one thing in common. That is high volume sell-offs. During the correction period most severe one day declines occur with extremely large volumes. That fact confirms the finding: most investors sell at the bottom. The reasons behind investor decision liquidating positions with loss are several but some of them include sharp shift in the investor mood led by panic, sharp rise in risk aversion, large funds lowering exposure. At the bottom is capital preservation. The factors are complex but the result is one – sell-off.
|The evidence that most investors sell at the bottom|
As seen on the chart after the initial fall usually there is dead cat rally followed by subsequent drop both combined with declining volumes. Here investors confidence is damaged and most decide to stay away of the turbulent volatile markets.
Actually that is the right time to enter – inversely to the public opinion as wise investors suggest. Combination of the sharp sell-off with extremely high volume could be used as a buy signal. The history shows that the best time to enter is some 5 to 10 days after the panic day. Employing the 200 day moving average could additionally give you margin of safety if sell-off occurs under that level.
Still no one can be sure where the bottom is. There is possibility of investment going under water but with patience and discipline the outperforming yield will come. Following the suggested patterns would let you buy cheap oversold assets which ultimately will boost your profitability. The bottom line in applying this or any other strategy is that simply have to be firm and don’t let market panic obsess you and your decision making. Quoting Graham again: “Even the intelligent investor is likely to need considerable willpower to keep from following the crowd.” i.e. discipline is the key for success. Don’t let others influence your decisions or strategy. Be THE intelligent investor!