Weekend Reading: Errant Thinking

Submitted by Lance Roberts via RealInvestmentAdvice.com,

Last week, I penned a post entitled “You Can’t Time The Market?” which was subsequently picked up on the Seeking Alpha website. It is always interesting for me to read the comments on the articles as it gives me a lot of insight as to the psychology of individuals currently investing in the markets. Specifically, it also tells me much about individuals who have never been through a “reversion” in the markets.

The article was addressing an individual’s ability to capture the upside in the market while missing a bulk of the downside by employing even a simple moving average strategy. To wit:

“While there are many sophisticated methods of handling risk within a portfolio, even using a basic method of price analysis, such as a moving average crossover, can be a valuable tool over the long term holding periods. Will such a method ALWAYS be right? Absolutely not. However, will such a method keep you from losing large amounts of capital? Absolutely.”

“By using some measures, fundamental or technical, to reduce portfolio risk by taking profits as prices/valuations rise, or vice versa, the long-term results of avoiding periods of severe capital loss will outweigh missed short term gains. Small adjustments can have a significant impact over the long run.”

Of course, this is where, despite seeing the chart posted above, this comment was left.

“Completely disagree since the market can trade at or near a record top for months or years. Yes, much of the time. Check a monthly chart of SPX. “

Okay, we can do that. As shown, while markets during the FIRST HALF of the market cycle can certainly elevate to extremely overvalued levels as exuberance displaces underlying fundamentals, the SECOND HALF takes generally wipes out all of the gains from previous break-even levels.

Unfortunately, given the fact that investors don’t live forever, unless they have contracted vampirism along the way, the issue of time horizons are a major problem of the recovery process.

It is this errant thinking that continually leads investors to believe that somehow this time is different.

While exuberance in the markets currently reigns as prices continue to reflect economic and fundamental perfection, this time is likely no different than the last. The only difference will be that those with experience will leave the markets with the money from those whom will ultimately gain the experience.

In the meantime, here is what I am reading this weekend.



Research / Interesting Reads

“Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality is distorted by a misconception.” – George Soros