When most people buy stocks they are confused about how they will make money and don’t really understand the process behind buying shares. This leads to impatience, irrationality, indecisiveness, and fearfulness.
Some may even end up panic selling shortly after they buy because they are now in the red. They then don’t understand what went wrong and call it a scam, or worse decide to never invest again because they had a bad experience.
I will use a real life example in this article to demonstrate this type of behaviour. I hope it helps you understand market moves better and why they happen.
Before we look at this example, I want to explain to you first that there are two primary ways to earn money from buying shares. Remember, these moves also don’t happen over night. Be patient, there are always opportunities.
Capital Appreciation - This is when the stock price moves up.
For example, today I buy stock (ABC) for R20, and next week stock (ABC) is worth R25 - I have made R5 a share.(25%). If I hold 1000 shares of stock (ABC) I would make R5000 in total if I sold.
However, for me to make R5000 in Stock (ABC) I would need to invest R20 000 of my own money at R20 a share to get 1000 shares in stock (ABC). I’m risking R20 000 of my money to make R5000 - that’s trading.
Dividends - If stock (ABC) is a dividend paying stock (company that pays out a percentage of their profits to shareholders) then I would be eligible to receive money from company (ABC) because I own shares of the company.
For example, If company (ABC) pays R2.50 per share in dividends, and I have 1000 shares, then I would receive (R2500.00) - a juicy 12.5% dividend yield. I could reinvest that money back into company (ABC) and buy more shares, or I could take the money and use it for something else.
Now, it’s easier said than done, and sounds like music to one’s ears, but in reality it can be a lot trickier than what it’s made out to be because we can be irrational at times and our emotions can cloud our judgements.
The term ‘buy low and sell high’ is thrown around like confetti at a wedding, and makes many believe that richness is only a few clicks away.
But what does it mean exactly?
Below is a perfect example of how irrational behaviour could influence our decisions. For those of you, like me, who have been following MTN Group would know that it has returned 113% year to date (YTD).
This will undoubtedly capture the attention of many simply because of irrationality and FOMO. Everyone wants to make money right?
But there is a catch, look at the graph below, MTN is showing signs of exhaustion and has been overbought.
It has reached a strong resistance area.
The RSI indicators are warning of it being overbought.
But this won’t stop people from buying it at these levels because they want to make 100% ‘quick quick’, too. These same people who buy now are speculating and will be the first to panic sell when they see red in their portfolios.
They end up ‘buying high and selling low’ the complete opposite of what they should be doing. This then creates temporary weakness in the share price, and could easily lead to a significant pullback (10%).
It would then become exacerbated by those buying the top and panic selling lower, which then could lead to more selling pressure as people try to protect their gains. This self-fulfilling prophecy of ‘buy high sell low’ starts to play out and the market moves through this irrationality phase.
This gives astute investors time to accumulate at lower prices, and gives traders an opportunity to once again buy lower and sell higher. The key here is to be patient. As mentioned earlier, there are always opportunities in the market, and if you miss one, another will come.
It’s best to follow stocks that are in an uptrend and then buy in areas where people are selling. Buy into weakness, but not immediately because selling pressure usually lasts, from my experience, for about 3 days.
It’s easier to see all this in hindsight, but with a bit of practise you can anticipate what ‘could’ happen. Instead of buying MTN now at R130, based on indicators, you could rather wait and buy it at (+-R115).
If it unfolds like I think it will, you would have an opportunity to load up on shares at a cheaper price, in a continued uptrend, which is evident from the higher lows and higher highs.
“buy low and sell high”
That’s it for this week, please feel free to reach out with any feedback, I’d appreciate hearing from you.
Have a fantastic week ahead.
For those of you that missed it, I was featured in EasyEquities research article where I discuss my 4 favorite shares and why I have backed them.
You can click here to read the article about my stock picks
Until next week, everyone.
Stay safe :)