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PR Newswire
16-01-2011, 08:25 AM
Jan 16, 2011
small change
Don't bank on 'greater fool' theory
If investors chase rallies too hard, they may end up with dud shares when the music stops
By Goh Eng Yeow, Senior Correspondent
In its outlook for 2011, global lender Citigroup believes that stocks are likely to report another year of double-digit gains.
But its advice to investors is not to chase the rallies too hard. Its rationale is simple.
'The key to success is to buy the dips as the grind higher must always climb a wall of worry,' it said.
Investors would do well to heed Citigroup's excellent advice. They should not fret that they may be missing out on the rally.
There should be plenty of buying opportunities if concerns resurface over the ability of European countries like Greece and Portugal to service their public sector debts, or China bungling its efforts to engineer a soft landing for its red-hot economy.
Still, heeding Citigroup's advice may be easier said than done.
As British magazine Economist noted, when it comes to the stock market, investors are more likely to flock to buy shares that have risen in price rather than wait patiently for a correction before making any purchases.
It said that this is due to the 'momentum effect' - investors chasing after the outperformers, rather than the laggards, when the market is hot.
But that is where the danger lies. Any veteran investor will tell you that a stock market buying frenzy resembles the gigantic warehouse sales staged by the huge departmental stores here.
Shoppers will simply snap up everything in sight because of the knock-down prices, not realising until much later that some of the purchases may languish unused in the closet for years.
In Singapore, this is best exemplified by the super bull run in July 2007 when buying into the right penny stocks at the right moment seemed like a sure-fire way to make quick money.
Some fancied counters even rewarded buyers with double-digit gains daily. Hundreds of millions of shares in loss-making firms such as Rowsley, Ban Joo and Jade Technologies changed hands daily - as the rumour mills went into overdrive over their prospects as takeover targets, by businessmen who wanted to inject fresh businesses into them.
But all this came to grief just a month later when a collapse in the sub-prime mortgage market in the United States triggered a vast financial firestorm which sent stock markets crashing across the globe.
As the great British economist John Maynard Keynes noted, taking a wager on the stock market is, in some sense, similar to gambling.
During the penny stock rally in 2007, most buyers knew very little about the counters they had bought into, as most of them were loss-making companies with few businesses left.
But the daily double-digit gains enjoyed by some penny stocks had lulled the buyers into believing that they would be able to sell the shares at a higher price to someone else.
Keynes described this investment gimmick as the 'greater fool' theory. An investor will be willing to fork out a big sum of money for a worthless stock, if he believes that a greater fool will be willing to buy it from him at a higher price.
These investors buy stocks for speculation. They may not care, or even know, what the firm does, so long as its share price goes up.
But in employing such a risky trading strategy, a trader must make sure that he is not the idiot who ends up holding the dud shares when the music stops playing.
And that is where Keynes turned out to be a genius.
While he made his fame from his economic theories, his uncanny reading of the human investment behaviour made him a very rich man, as he made numerous successful forays into the stock market.
Still, that does not mean that an investor will have to be a behavioural scientist in order to be successful in stock investing.
Borrowing a strategy or two from successful poker players may be useful.
The late Mr Puggy Pearson, a colourful gambler who won the World Series of Poker in 1973, once said that the key to his success boils down to three things.
'Know the 60-40 end of a proposition, money management, and know yourself,' he said.
In a 60-40 proposition, a gambler has a 60 per cent chance of winning a bet.
Take horse betting. The expectation that a certain horse may win is reflected by the odds given on the scoreboard, while its performance will depend on its form during the race.
Mr Pearson noted that a gambler does not make money knowing which horse will win or lose. Rather, he makes the big bucks from knowing whether the odds on a horse have been mispriced.
Stock investing is similar in some ways. How a stock performs will depend in a big way on investors' expectations, rather than the income which its business may be making for them.
One mistake made by most investors is the urge to want to buy stocks which are on the upswing - and sell when the picture looks bleak.
It may be better for them to look out for counters with good businesses which have been unfairly priced down by the market.
They will then enjoy a better chance at making money out of these counters.
Take the huge bear market between December 2007 and March 2009. Solid companies such as DBS Group Holdings, OCBC Bank and Singapore Airlines tumbled to their lowest levels in almost a decade, as investors' expectations hit rock bottom.
This is a classic case of the odds being mispriced, as Mr Pearson would put it, given the attractive businesses possessed by these blue chips.
Since those dark days, those who were brave enough to take a bet on these counters would have doubled on their money.
Going forward, there is likely to be other instances of mispricing of the odds, as investors' expectations take a hit from the spate of bad news hitting the market.
If you take Mr Pearson's advice to heart, you may well find yourself at the attractive 60-40 proposition end of making a profit on your trades.
Happy new year and invest wisely.
engyeow@sph.com.sg
--------------------------------------------------------------------------------
A matter of perception
How a stock performs will depend in a big way on investors' expectations, rather than the income which its business may be making for them.
small change
Don't bank on 'greater fool' theory
If investors chase rallies too hard, they may end up with dud shares when the music stops
By Goh Eng Yeow, Senior Correspondent
In its outlook for 2011, global lender Citigroup believes that stocks are likely to report another year of double-digit gains.
But its advice to investors is not to chase the rallies too hard. Its rationale is simple.
'The key to success is to buy the dips as the grind higher must always climb a wall of worry,' it said.
Investors would do well to heed Citigroup's excellent advice. They should not fret that they may be missing out on the rally.
There should be plenty of buying opportunities if concerns resurface over the ability of European countries like Greece and Portugal to service their public sector debts, or China bungling its efforts to engineer a soft landing for its red-hot economy.
Still, heeding Citigroup's advice may be easier said than done.
As British magazine Economist noted, when it comes to the stock market, investors are more likely to flock to buy shares that have risen in price rather than wait patiently for a correction before making any purchases.
It said that this is due to the 'momentum effect' - investors chasing after the outperformers, rather than the laggards, when the market is hot.
But that is where the danger lies. Any veteran investor will tell you that a stock market buying frenzy resembles the gigantic warehouse sales staged by the huge departmental stores here.
Shoppers will simply snap up everything in sight because of the knock-down prices, not realising until much later that some of the purchases may languish unused in the closet for years.
In Singapore, this is best exemplified by the super bull run in July 2007 when buying into the right penny stocks at the right moment seemed like a sure-fire way to make quick money.
Some fancied counters even rewarded buyers with double-digit gains daily. Hundreds of millions of shares in loss-making firms such as Rowsley, Ban Joo and Jade Technologies changed hands daily - as the rumour mills went into overdrive over their prospects as takeover targets, by businessmen who wanted to inject fresh businesses into them.
But all this came to grief just a month later when a collapse in the sub-prime mortgage market in the United States triggered a vast financial firestorm which sent stock markets crashing across the globe.
As the great British economist John Maynard Keynes noted, taking a wager on the stock market is, in some sense, similar to gambling.
During the penny stock rally in 2007, most buyers knew very little about the counters they had bought into, as most of them were loss-making companies with few businesses left.
But the daily double-digit gains enjoyed by some penny stocks had lulled the buyers into believing that they would be able to sell the shares at a higher price to someone else.
Keynes described this investment gimmick as the 'greater fool' theory. An investor will be willing to fork out a big sum of money for a worthless stock, if he believes that a greater fool will be willing to buy it from him at a higher price.
These investors buy stocks for speculation. They may not care, or even know, what the firm does, so long as its share price goes up.
But in employing such a risky trading strategy, a trader must make sure that he is not the idiot who ends up holding the dud shares when the music stops playing.
And that is where Keynes turned out to be a genius.
While he made his fame from his economic theories, his uncanny reading of the human investment behaviour made him a very rich man, as he made numerous successful forays into the stock market.
Still, that does not mean that an investor will have to be a behavioural scientist in order to be successful in stock investing.
Borrowing a strategy or two from successful poker players may be useful.
The late Mr Puggy Pearson, a colourful gambler who won the World Series of Poker in 1973, once said that the key to his success boils down to three things.
'Know the 60-40 end of a proposition, money management, and know yourself,' he said.
In a 60-40 proposition, a gambler has a 60 per cent chance of winning a bet.
Take horse betting. The expectation that a certain horse may win is reflected by the odds given on the scoreboard, while its performance will depend on its form during the race.
Mr Pearson noted that a gambler does not make money knowing which horse will win or lose. Rather, he makes the big bucks from knowing whether the odds on a horse have been mispriced.
Stock investing is similar in some ways. How a stock performs will depend in a big way on investors' expectations, rather than the income which its business may be making for them.
One mistake made by most investors is the urge to want to buy stocks which are on the upswing - and sell when the picture looks bleak.
It may be better for them to look out for counters with good businesses which have been unfairly priced down by the market.
They will then enjoy a better chance at making money out of these counters.
Take the huge bear market between December 2007 and March 2009. Solid companies such as DBS Group Holdings, OCBC Bank and Singapore Airlines tumbled to their lowest levels in almost a decade, as investors' expectations hit rock bottom.
This is a classic case of the odds being mispriced, as Mr Pearson would put it, given the attractive businesses possessed by these blue chips.
Since those dark days, those who were brave enough to take a bet on these counters would have doubled on their money.
Going forward, there is likely to be other instances of mispricing of the odds, as investors' expectations take a hit from the spate of bad news hitting the market.
If you take Mr Pearson's advice to heart, you may well find yourself at the attractive 60-40 proposition end of making a profit on your trades.
Happy new year and invest wisely.
engyeow@sph.com.sg
--------------------------------------------------------------------------------
A matter of perception
How a stock performs will depend in a big way on investors' expectations, rather than the income which its business may be making for them.
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
