Conventional investing advice is to buy low and sell high. Although it works in theory and is even considered a no-brainer, investing is obviously much more complicated than this. Hindsight is 20-20 but in real time, emotions can get in the way. When you try to chase returns, you end up on the wrong side of the market — buying when stocks are high.
The Herd Mentality
This is called a herd mentality. “It is easily seen in investing through the cyclical frenzied buying (bubbles) and frantic selling (crashes) of the stock market,” writes U.S. News and World Report. “These sudden swings are rooted in irrational investing practices and driven by emotion — greed in bubbles and fear in crashes.” Investors determined to stay on the profitable side of the deal often end up patterning their investing off what the market is doing, not what the stock is worth based on its fundamentals.
Sure. An event could trigger stock movement — a company files for bankruptcy, a CEO steps down, earnings come in under guidance — but it doesn’t last. As soon as the market realizes what is happening, the share price turns. In response, an investor following the herd will start selling into that shift, dumping shares of stocks that are going down or scrambling to buy a stock on the rise. The problem is that these actions exaggerate the stock’s price, inflating or deflating it artificially. In a few days (or hours), the momentum is gone and the stock goes back to a form of equilibrium, leaving the emotional, herd-focused investor with significant losses.
Luckily, there is another way. When you abandon this herd mentality and form an objective strategy, you set the stage for long-term growth. Benjamin Graham explained this concept in his landmark book, “Intelligent Investor.” He advised investors to examine company fundamentals and calculate a price for the stock that makes sense based on its financials and market. Graham’s recommendation was for investors to buy when the stock’s share price dips below that level and sell when the share price rises significantly above that measure. Because of its effectiveness, his advice has been followed by scores of investors, including the venerable Warren Buffett.
If you want to be a successful investor, you need to focus on managing your risk instead of chasing gains. Set your sights on minimizing loss and focus on buying for value, not emotion.