How do you manage your investments in the financial markets, avoiding the Big Fool’s Dilemma?

The Chinese legend of war strategies “Sun Tzu” changed the way battles were fought through his most famous book “The Art of War”, which serves as a guide to winning wars and conflicts.

Sun Tzu wrote in The Art of War: “Those who win every battle are not skilful, and those who render the armies of others useless without a fight are the best of all.” This “fight without a fight” is more of a mental challenge than an actual physical fight.

It is always difficult to easily navigate the stock market without problems, and investing is like preparing for a battle. Both require assessing the situation, developing strategies, conducting in-depth research, managing risks and developing scenarios. Sometimes you think everything is easy, but that’s not true.

The Big Fool Theory The motive behind speculation

You must always be knowledgeable and aware of the market and not always be guided by wrong bets. Some argue that the market can be entered at any time and from any direction, depending on the “greater fools” theory, which states that one can always profit from a market bubble by buying a more expensive asset and selling it later for a profit because there will always be be customers willing to pay more.

Of course, speculators who rely on this theory often face difficulties when it does not materialize when a correction occurs. The whole theory is based on making money by predicting future price increases regardless of market conditions, and it assumes that there is not just one fool in the market, but many. The mechanism of investing in this way is based on the creation of speculative bubbles that may one day burst and lead to a crisis. They do not always promise higher returns and can be very harmful to investors because they are not based on the intrinsic value of the asset and the expectation that it will achieve a higher return in the future, but it is about making money by speculating on future price increases regardless of market conditions.

But the truth is that successful investing is more than the ability to pick a good stock because you will be surprised to know that most investors can do this. Excellence is the angle from which you pick a stock, and having a unique angle can put a safety net behind your operations, which is essential if you intend to tip the odds in your favor. Never forget that investing is a game of probability and you will be rewarded not only by predicting the right ratios when there are signs that you are going in the right direction, but also by managing your losses when things don’t go as planned.

The most important thing is that you will suffer losses, you should expect to go through periods where you lose, and this is even more important because most people find it difficult to accept the fact that they were wrong. This sometimes results in losses that outweigh gains, so most investors do not stand the test of time. Investors may not be risk averse and risk averse for a number of reasons, but they are loss averse and the possibility of loss greatly influences their decisions.

efficient market theory

Others take the different view that markets are generally efficient. Efficient market theory assumes that stock prices reflect all information and that stock performance is consistent with fundamentals. Therefore, it would be impossible to beat the market as a whole through stock picking or market timing, and the only way an investor can get higher returns is by buying higher risk investments. Proponents of this theory encourage investors to take advantage of investing in passive portfolios, while opponents argue that the market can be beaten and stocks can deviate from their fair value.

What drives markets in the short term?

In 2020, around 24 million new investors joined the stock market, supported by government incentives and a lack of other areas to invest. These new investors poured money into the most sought-after stocks. Scientists explain the enthusiasm of new investors with the positive feelings that arise from various human actions, including purchases, and say that the brain releases the chemical dopamine that causes a feeling of happiness when people buy things, so for many, buying anything is a simple way to satisfy an innate need to you feel good. . People just like to own things and they really need to feel good.

What happened next was a huge increase in the stocks that these new investors wanted to buy, and with it the birth of the “meme” generation and the creation of another bubble that will be studied historically. But as with many bubbles, it’s good to think about what went wrong and what to do next.

It’s good to know what moves the markets in the short term because it will allow you to manage your emotions. The bottom line is that trying to predict short-term fluctuations in a particular stock, stock market, or economy is unlikely to yield consistently successful results. In the short term, future developments are uncertain. Uncertainty will always be there, no matter how much we want to know what the market will do next. The future cannot be predicted and no one can predict it, so the answer is to ignore the prophecies and continue on your way.

How do you deal with the market?

We live in a cyclical world. The irregular component of the time series is excluded leaving only regular or cyclical deviations around the general trend that show a series of growth and contraction phases. Many things in today’s world follow a pattern or occur at predictable intervals. Climatic and weather cycles, biological and organic cycles, agricultural and medical cycles, these are just some examples.

The stock market is also cyclical. However, the mental outlook for investing and trading generally affects price movements in the markets. This is where you can gain a psychological advantage over the public. Proponents of this trend point out that long-term price movements are the result of economic conditions, while short-term movements are the result of changes in public perception.

The history of the speculative cycle, they say, repeats itself over and over again. From the tulip flower pattern to Internet stocks, the pattern is the same, just in different forms.

Investing is about exercising self-control while trading and not competing with others, as an investor’s worst enemy is himself.

How do you determine the speculative cycle?

It is initially characterized by high prices with little or no public interest, with mild volatility, limited public interest, small volumes and some short-term interest. No one is talking extensively about the market and very few think this could be a long-term opportunity. Trading volume is low and companies do not publish news.

Buyers and sellers are the same. Some investors believe that the cycle will end and therefore expect a reversal. Prices theoretically reach their lowest levels after the sale.

The market is slowly growing, the general public is looking at it, but they want to wait for a better opportunity to enter. Prices continue to rise and begin to attract media attention. Ultimately, investors are forced to buy at any price, usually driven by a desire not to miss out. The media publishes great news and market experts are in a position to make perfect predictions, and some investors will think it’s easy. Over time, there is a shortage of sellers and an increase in buyers. When all customers get their hands on the inventory they want, the change begins. Prices continue to fall to the point where buyers can no longer bear the pain, prices become low enough for long-term buyers to enter the market, and then the cycle begins again.

What should you do?

Use cyclical market and stock patterns to time your entry. Being patient and waiting for the right moment can save you a lot of stress and, of course, a lot of money. Locate that cycle, whether it is at the beginning, middle or end, select your stock list. Keep a list of your stocks. Be sure you know what you want to buy, at what level and valuation, and how much you are willing to risk. Being prepared is half the battle. Everyone is the greatest investor in the world, but it’s too late. The great investor Peter Lynch once said, “The most important lesson I have learned to be a successful investor is the need to maintain emotional detachment.”

Choose your angle

Look for companies that are not covered by research firms and expert ratings. These may include IPOs, secondary listings, stock splits, spin-offs and unpopular securities. Look for stocks that are being ignored by research analysts and trade on low margins as a result. Also look for companies that have announced strategic changes. Remember that you are buying a margin of safety and that when things go wrong, the market will sell off indiscriminately.

Be confrontational, go against the herd and you’ll win big. Make sure there is a catalyst to turn price into value. Don’t buy stocks just because they are cheap, but because there is an additional catalyst to turn price into value.

Protect your capital, if you can’t understand what’s going on, stay out of the market and remember you won’t be penalized just because you didn’t win.

In the end, as Sun Tzu says, “He who knows when to fight and when not to fight will win.”

Sources: Arqaam – Forbes – Seeking Alpha