Understanding Stocks

by Michael Sincere

in which prices of goods and services fall. Although inflation is common, deflation is quite rare in the United States (Japan, however, was in a deflationary environment for over two decades).

To the uninformed, deflation seems like a good thing. The prices of nearly everything fall as the supply of goods piles up. Manufacturers are forced to cut prices to entice buyers. On the other hand, companies cut employees, real estate prices fall, and the stock market goes through a rough period. Prices are low, but few people have...

One of the best ways to protect against deflation is to get out of debt. That means paying off credit cards, car loans, and possibly the mortgage (although you should ...

In addition, force yourself to save more. If we really do have a deflationary environment, those with the most cash will prosper. Because deflation is so unusual in the United States, there is no need to be especially concerned. Just keep a close ey...

A bubble is a phenomenon in which investors and traders pursue stocks (or other items) at such a feverish pace that prices rise to irrational levels. Buyers seem to be under a mass delusion that the market can only go higher. Before long, speculators hoping for quick profits jump in, creating a mania. Eventually, investors come back to their senses, buyers disappear, and prices fall. That can lead to a selling panic. There have been a handful of bubbles in history, all of which ended quite badly for investors. One of the most spectacular bubbles in history occurred in Holland in the seventeenth century. In 1635, people were willing to pay nearly any amount of money

tulip bulb. These bulbs became status symbols for the rich and famous, including the Dutch royals. Some of the bulbs were beautiful mutations, what the Dutch called “bizarres.” Speculators would buy one and then immediately sell it for a higher

The U.S. also has had its own share of bubbles. When the 1920s began, the stock market was generally for the idle rich who bought and sold stocks at their leisure.

prices were volatile and moved up and down through most of the decade. By 1927, however, there was a strong upward trend (i.e., a bull market) and even small investors became enamored of the stock market. With the introduction of buying on credit, members of the middle class were able to buy autos, washing machines, vacuum cleaners, clothing, and radios—items that previously only the wealthy could afford. At the same time, steel production and manufacturing increased. As a result, the stock market boomed, a fact that was constantly publicized in the newspapers. “It’s a bull market!” the headlines blared. Soon, everyone dreamed of getting rich by investing in stocks, including people who had never invested before. Some people thought the stock

Those who couldn’t afford to buy stocks could buy on margin with very favorable interest rates. Margin requirements were as low as 10-to-1, so if you had $1,00...

brokerage firm would lend you an addi...

the stock market got shakier and the economy got worse, the new president, Herbert Hoover, realized that something had to be done.

The goal was to tighten margin requirements without causing panic. Unfortunately, investors panicked.

After a series of frightening stops and starts, the market finally crashed on October 24, 1929. Over $10 billion of investors’ money was wiped out before noon. Huge crowds of angry and sh...

watch the debacle. By noon the market was in a...

Investors around the world were horrified at the extent of the financial damage. By October 29, 1929, all the market’s gains from the past year had been wiped out (but that was just for starters). Over the next three y...

One of the reasons the market crashed in 1929 was because of margin. As the stock market fell, people who had bought stocks on margin didn’t ha...

That’s when investors had to sell stock at any price just to raise cash to repay their margin debt. Banks and brokerages stepped in to take possession of people’s savings accounts, houses, and anything else they could ...

In the late 1990s, many Internet stocks surged by dozens of points a day, turning many people into paper millionaires. Investors were deluded into thinking

Less than 10 years later (at the beginning of the twenty-first century), there was also a housing bubble, which resulted in the doubling and tripling of housing prices. Some people made fortunes buying and selling houses without ever taking possession of the houses (i.e., flipping). The entire country was swept up in the housing mania, and no one imagined that housing or stock prices could go down. Ironically, the housing bubble also helped fuel another stock market bubble (along with low interest rates).

Just like the tulip bubble, the housing and stock market bubble ended abruptly. Investors looked around and wondered how they could have paid so much for stocks with little or no earnings, and many houses that were bid up suddenly plunged, creating a foreclosure crisis.

because of mistakes. There is nothing wrong with making mistakes. Actually, the

not recognizing that you made one. Fortunately, I studied my blunders and worked hard not to repeat them.

There is something else you should know: Many investors listen to the wrong people, get too emotional about the market, buy and sell based on fear and hope rather ...

Mistake

Also, it’s not a mistake to lose money, because not every trade can be a winner. But it is a mistake to let a small loss turn into a much bigger

Sometimes you have to do the opposite of how you’re feeling. In fact, sometimes the right decision is the one that seems to be the most uncomfortable.

After a correction or crash, it’s not easy to buy. More than likely, you may feel like avoiding the stock market altogether. You must not succumb to fear and panicky decisions by putting

all your money in a savings account at the...

Conversely, when the market is reaching all-time highs and investors are giddy about how much money they’re making, it’s difficult to resist the crowd. When other...

are geniuses in a bull market, you must remain unemotional. Reduce your stock positions, hedge your holdings, or reallocate assets. It’s easy to forget that in bull markets the positive sentiment can change quickly. Be...

To refresh your memory, some of the signs of a potential market reversal include: the market is going higher on declining volume, leading stocks are faltering, there is a strong market opening but a weak close, and there is more than a day or two of weak closes. All these clues indicate ...

have read this book, there will be other bull and bear markets. If the market is falling by 10 or 20 percent, remember to stay calm and look for an opportunity to calmly reenter the market. There is no need to go all in to try to seek the bottom. This is no...

stock market again” or who predict the end of the world as we know it. It’s also ...

Almost as harmful to your portfolio as fear and greed is hope.

“Hope is a dangerous thing.”

In love as in life, there is always hope that things

work out in the end. In the stock market, however, hope can wreck your portfolio. If the only reason you are holding onto a stock is because of hope (and not for fundamental or technical reasons), you will probably lose money. Typically, investors are hopeful when they should be afraid, and afraid when they should be hopeful. The best attitude you can have is a neutral one. Don’t come into the market with preconceived ideas of how much money y...

Using technical or fundamental indicators for guidance, having a strategy, and sticking to that strategy are a lot more useful than coming up with an opinion and waiting for the market to agree with you. Don’t forget...

I’ve mentioned this earlier, but it’s worth repeating. If you don’t have a plan, then you’re flying blind, perhaps

relying on tips or impulses to make investing decisions. For example, you might wake up one morning and decide to buy gold simply because you read a positive article about that idea. Or you might decide to sell one of your profitable

whim because of something you heard on television. The main point is that you should have a plan. If you don’t, you are vulnerable to making impulsive decisions and listening to wrong opinions, dumb tips, and bad advice. Have...

Mistake 5: You Are Not Disciplined...

of rules, and no matter what you are feeling, you stick to your strategy, plan, and rules. Discipline means having the knowledge to know what to do (the easy part) and the willpower and courage to actually do it (the hard part). This has always worked for successful investors and professional traders.

Although discipline is essential, you also need to balance this with a healthy dose of flexibility. Some investors are so rigidly disciplined about

strategy that they stop thinking and blindly follow their plan. Markets do unexpected things and you must react when the market and stocks turn against you. In the name of discipline, some rigid investors refuse to admit defeat. Discipline is essential, but you must be realistic enough to realize that your plan could be a losing plan. You have to be flexible enough to change your plan, and your rules, under unusual conditions. Neverthele...

In fact, one of the easiest ways to lose money in the market is by listening to tips, especially if they come from opinionated blowhards on financial programs, well-meaning acquaintances, or columnists. These people often become cheerleaders for a stock, trying to convince you to buy (and sometimes sell).

month researching a $600 television set. If you do receive a “can’t lose” tip that is impossible to resist, buy in small quantities.

There are many exceptions, but generally, if you hold onto your winning stock positions and get rid of losers, you should see a huge improvement in your investment results. Most people do the opposite: When they have a winning stock, they sell as soon as they have a small profit, sometimes missing out on the biggest move. And when they have losing stocks, many tend to hold, hoping they will get back to even.

One strategy investors use is buying on the dip, where investors buy more shares of a favorite stock as it drops in value. Although at times this strategy may work, in my opinion, this is a risky strategy. More often than not, the stock keeps falling. I’ve

lesson: Stocks can go lower, or higher, than you ever thought possible.