It is a well-known fact that the markets are ruled by two human emotions: Fear and Greed. I am going to show you why both these emotions can cause you to make enormous mistakes in a stock market crash and why you should prepare yourself now to avoid making them.
Incidentally, I am going to talk about a mistake that 85% of people make in a market crash and one that I myself made in the year 2000 which caused me heavy losses. If you learn from this, you can avoid financial suicide.
Remember: the wise man not only learns from his own mistakes, but from other people’s mistakes…
The Dot-Com Donkeys
I will never forget January 2000 where I had my first taste of dabbling in stocks. In case you don’t remember, that year was also the height of the dot-com bubble. Technology stocks were soaring through the roof and greed had control of the market. Ordinary people from taxi drivers, teachers and plumbers were drooling at the idea of making a fortune in stocks.
I had been watching the stock of one particular company very closely. Exodus Communications Inc (EXDS) had tripled in value from $20 to $60 in just two months. I was thinking to myself, wow what if this stock now goes to $100, $200 – heck, all the way to the moon! How could I miss such an opportunity! (see chart below)
I finally bought the EXDS at $65. Now all I had to do was sit back and watch my trading account get fatter than a turkey before thanksgiving. By March 2000 the stock was just under $90. I could not believe my luck. “Good call!” I was saying to myself.
Very soon, my luck ran out. By April of that year EXDS was at $50 and by May it was at $40. Then a voice inside my head said: “Hey, why don’t we buy some more – now they are cheaper!” I dug into all my savings and I spent every last penny on buying even more of that stock. After all, it was an “investment”.
“Buy low, sell high”, right? Isn’t that what we have been taught?
Wrong. By May of 2001, a year later, the stock had plunged to less than $10. This was an 85% drop from the original price I had bought it at. Eventually, in September 2001, I was finally put out of my misery: EXDS filed for bankruptcy.
Fear and Greed
There is no doubt about it. What I did in the year 2000 is what “donkey” investors do – also referred to as “dumb money”. The smart money was selling technology stocks and dumping them unto the small guys. This is the way the markets have always worked and will always work.
Two emotions were ruling the marketplace:
1) Greed: the desire to make money
2) Fear: The fear of missing out on a huge opportunity
Notice that this is a different kind of fear than the one experienced by investors during a market crash: the fear of losing money.
The No.1 Mistake
What I want you to understand is that you must never buy a stock (or commodity) simply because it is “cheap”. That is not a good enough reason to buy. What you are essentially doing is trying to catch a falling knife! You are going to get hurt.
This mistake is often perpetuated by the misleading phrase: “Buy low, sell high”. This phrase is often misinterpreted for: “If it is cheaper then buy it, and sell it when it gets more expensive”. That is total garbage.
You see, what most people don’t realise is that when a stock (or commodity) is falling, the trend and momentum direction of that market may have changed.
Here is a case example:
In 2008, friends were telling me they were buying Lloyds TSB shares at £2.00 ($3 USD) because they thought it was a bargain. It was not – that company’s share price went all the way down to 50 pence! Those shares have not recovered since then and at the time of writing sit at 35 pence (see chart below):
I know what you may be thinking: “What if you waited a few years for the price to recover – then at least you’ll get your money back and break even.”
OK, let’s say that you are lucky enough that your stock recovers and in three years it has come back to the original price you bought it at. You have your money back, well done. But you have lost something you will never get back: Time. Three years!
During those three years you could have been shorting that market (making money downwards – and more on that in upcoming posts), or investing in stocks that were going up.
Be prepared. If we are indeed heading for another stock market crash, and I believe we are, then you need to take control of your emotions right now!
Stocks will get cheaper, and cheaper. If you listen to the voices of greed inside your head saying to you: “Hey, at this price, this stock is a bargain!” you are setting yourself for financial suicide. For the bargain hunters, there is only one way their story will end: in tears.
I will show you in later posts that the stock or commodity needs to show some positive signs of strength before we decide to buy it.
Did this article help you? What are your own views? Have you made similar mistakes? Feel free to leave me your comments below.