Market fluctuation is a key reason for people to believe that investing in stocks is risky and should be avoided altogether. Many dreamed of investing profitably in stocks, but at the same time, are afraid of incurring losses from a fall in stock prices. This fear has been accentuated, especially today as we face immense political, economic and pandemic challenges concurrently.
In this article, I’ll share my take on market fluctuations and more importantly, a practical solution to deal with it so that we could invest with greater confidence in the stock market.
Why are Market Fluctuations Huge in the Stock Market?
For a start, we need first to appreciate the fact that the stock market consists of many different participants. They include the range from retail investors with small amounts of capital to institutional fund managers who are managing billions of dollars worth of investment funds. Each would have different reasons for buying stocks in the stock market.
For instance, some investors buy shares intending to hold onto them for the long-term. Their reasoning for buying into stock is usually logical and understandable. Some traders trade shares for a quick buck in the short run. Also, there are speculators who “chase” shares to try out their luck in similar to gambling. Most traders and speculators do not hold stocks for the long run.
Typically, markets work in cycles. There are good times and bad times. Both will swing back and forth like a pendulum. Hence, when times are good, and income is rising, people are encouraged to ‘take some risks’ and buy stocks. This will lift stock prices, which helps more people (traders and speculators) to buy more shares in search of ‘capital gains’. Hence, this explains why stocks could be ridiculously overpriced as they are not purchased based on logic but greed itself.
When times are bad, like what we are experiencing today, there would be news and reports to accentuate its effects on our economy. Based on a bleak outlook, institutional investors, especially the ones that need to show short-term results to their clients, may dispose of their stocks in the market. Often, it caused a fall in stock prices which ignited panic selling from traders and speculators. As such, this also explains why stocks can be ridiculously undervalued because the disposal of shares are not based on logic, but the emotion of fear itself.
How Do Most People Lose Money in the Stock Market?
I find that most people who lost money in the stock market are people who are intending to make capital gains fast from their stock purchases. They opine that the stock market is a place to earn quick bucks with minimum effort. It is truly a fallacy and a flawed view about profiting from the stock market.
Let me illustrate how most people lose money in stocks:
- They buy stocks to earn capital gains, not dividend yields. This is because the profits from capital gains are more appealing than dividend yields.
- Unconsciously, they opine that good stocks are ones where their stock prices are moving upwards. This opinion can be further substantiated with favourable news, reports, and comments about these stocks from different sources, online or offline and either official or unofficial.
- How do they know that the stock is a good one? Answer: They look at charts. If a stock has risen in prices, then, it is a good stock as it is moving upwards. If it is rising, they opine that it will move higher in the future. Fearing of losing their bandwagon, they would make their purchase for the stock.
- Two things would most likely happen. First, it rises further. Hence, the people who bought into it are feeling great about themselves as their ‘investments’ are working. So, they would buy more at much higher prices. This is referred to The Greater Fool Theory for their capital gains are reliant on having more people or ‘fools’ to buy the same stock at higher prices.
- Second, its stock price may fall. The people who bought into its shares would either hold onto them as they believe that its stock price would ‘recover’ in due time. If it does not, they would sell their stocks to cut their losses and conclude that stocks are risky investments when, in fact, they are speculating.
The odds are not in favour of these speculators. Why? This is because they tend to buy stocks after their prices went up significantly. This means, if the prices of their stocks rise further, they make lesser capital gains as compared to the ones who bought them earlier. Also, if the prices of their shares fall, they incur higher losses as compared to the ones who bought them at lower prices earlier.
That is why most traders and speculators do not last long in the stock market.
How to Make More Money if Stock Prices Rise and Lose Lesser if Stock Prices Fall than Other People in the Stock Market?
Benjamin Graham, a mentor to Warren Buffett, a living investment legend once quoted, ‘Investing is most intelligent when it is most Business-like’. Thus, instead of treating shares like lottery tickets, we should assess the investment potential of stock as if we are going to be a long-term partner of the company.
True investors are cash-flow orientated. When they analyse a stock, they will want to find out its business model, management team, the track record of earning profits and generating cash flows, cash-in-hand and its plans to create more profits and cash flows into the future. This is usually Step #1 in stock investing.
Step #2 is about valuation, an art to assess if the stock is cheap or expensive. Its method of assessment involves calculating valuation ratios of a stock such as its P/E Ratio, P/B Ratio and Dividend Yields, plus all sorts of valuation models, and comparing with its peers of the same industry. As such, it encourages investors to buy good stocks when they are undervalued and avoid any ridiculously overpriced investments.
The odds would be in favour of investors because they are encouraged to invest in stocks when they are undervalued, which mostly happen when the prices for their preferred stocks fall in the stock market. So, in the event their stock prices increase in the future, they make more money. If the stock prices decline in the future, they lose less money as compared to others who bought them at higher prices in the stock market.
Conclusion: My Personal Views on Market Fluctuations
In short, I view market fluctuations as a friend to investors but a cruel enemy to speculators. This is because huge market fluctuations enable investors to invest into great businesses at absurdly undervalued prices and provide opportunities to dispose of them if they are ridiculously overpriced. It enables savvy investors to ultimately build long-term wealth and passive income from stock investing.
But, the road to investment success requires one to begin by learning, studying and mastering investment skills like accounting and stock valuation. Most don’t have the desire or time to learn and practise them by themselves. As such, they should not be investing their money into the stock market.
With that being said, if you wish to learn more about stock investing, we have a 90-minute webinar session where we would discuss how massive profits can be made from investing into good stocks safely at the right prices.