The stock market tricks many people into parting ways with their hard-earned cash. The stock market can be a trap just like gambling on the horses can be.
What’s the problem? People try and predict the bottom of the stock market so they can buy at a low price and take advantage of the discounts. As consumers, we’re taught to buy things at a discount and applying the same logic to buying shares seems logical.
Trading stocks is dangerous and it’s risky. A lot of people lose some or all of their money trying to do so. In fact, less than 1 in 4 retail investors make money from the stock market. It doesn’t have to be that way, though (not financial advice).
Here are the four things that can trip you up trying to predict the bottom of the stock market:
1. The Bear Trap
Unless you are a professional and understand in great detail how the stock market works, the notion of a bear trap can cause cataclysmic failure with your investment strategy.
A bear trap is where the price of stocks starts to form a downward trend and the unsuspecting investor places trades that predict the price will continue to go down. Then, the reverse happens. The bet of the price going down is actually a trap and the stock market goes in the opposite direction.
What causes people to fall into a bear trap is the news and social media. They portray a world event like a health crisis — forcing the majority of the planet into isolation — as a logical event that explains the price of stocks.
Over the years, when you’ve been in the game a while, you realize these important facts:
The stock market is illogical.
The stock market is based on emotion, not evidence.
The stock market can be manipulated by governments inflating stock prices artificially and printing money.
2. Prolonged downturns
Another trap in the stock market is prolonged downturns. If you were buying stocks in Japan in the late 80s, you would have been on top of the world. You would have thought you were born in the lucky country.
What followed in Japan was a prolonged downturn that the country still hasn’t recovered from today, reflected by the fact that the Bank of Japan owns 40% of the local companies listed on the stock exchange and more than 40% of local government bonds.
In the 1930s another prolonged downturn occurred known as The Great Depression. Nobody can predict when a prolonged downturn can happen. It can be triggered by a whole range of world events.
These events take investors by surprise and cause stock prices to become flat or negative for a number of years. Most of the time the stock market will recover — except in Japan — but investors are not generally that patient. Instead, once the average person has witnessed a downturn in the stock market that lasts a year or more, they sell all their stocks out of fear.
3. Upside-down financial markets
The stock market is logical when you study it. It’s set up with a purpose and the markets are efficient. The idea of freedom created the notion that the stock market a “free market.” And it is. Anyone can invest.
The challenge is that the financial markets are upside down. These are some of the signs of the upside-down, illogical financial markets:
- Negative interest rates
- Below zero oil prices
- Negative yielding bonds
- Stock markets going up with record unemployment and civil unrest
- Bailouts for corporates
- Money printing
- Stimulus checks
Nothing makes a whole lot of sense in finance anymore. If you don’t understand what has caused the financial markets to radically change, then you risk misunderstanding how low or high the stock market really is.
4. A second wave
A virus is not like any other global event. It’s unpredictable and it doesn’t care whether you have twenty people allowed in a tiny restaurant or one hundred.
The risk is that a second wave of the virus hits and takes those who are complacent and not taking precautions by surprise. This health crisis makes trying to predict the bottom of the market nearly impossible. Without a second wave, things should recover. With a second wave of the virus, the stock market could look really ugly real quick.
What You Can Do
The stock market may look ridiculous after everything I have just said. It may seem like there isn’t a solution — but there is. This is my approach:
- Take more caution than normal
- Don’t get ahead of yourself
- Invest money you can afford to lose
- Diversify where you invest your money
Know what the heck you’re buying!
Many people buy paper investments or financial products that have leverage (leverage means you are going into debt when you invest — often without knowing).
Paper investments are ones like Gold ETFs where you think you’re buying gold and then when you do your research you find out there’s no gold in sight. When things go bad in the financial markets like they did in 2008, these paper products can often be one big lie. The issuer of the ETF products says they have gold in their vault and then when the financial crisis hits you find out they don’t have enough gold for everyone.
How do you get around these paper products? You buy the real thing. If you want gold, then buy gold. If you want digital currencies, then buy them.
In 2008, a product known as collateralized debt obligations allowed bad debts to be packaged up with good debts and be sold off.
As a result, the buyers of these products (the banks that store your money and pension funds that invest for your retirement), required huge bailouts. This is why it’s often better to own the real thing than a product made up by a bearded dude in a pinstripe suit who is paying the lease on his Ferrari with the collapse of your finances.
Leverage products are the same. Right now an alarming number of people who are spending more time at home are investing in the stock market. The challenge is they are using products with leverage without knowing it. They are buying $10,000 dollars worth of shares with $2000 in cash and being told that the product has special powers and can produce higher returns.
Borrowing money to invest in stocks is like stealing money from your children’s future to buy yourself a new car today.
In my view, you either own a company like Amazon or you don’t. Everything else is murky and that puts your money at risk during uncertain times.
One solution: Dollar-Cost Averaging
This strategy is one I’ve been using for years. It’s the solution to a lot of the problems that investing in stocks brings about.
Rather than try to predict the prices of stocks, assume you’re always going to be wrong. Choose an amount of money to invest each month and stick to it.
You might decide to invest $1000 a month. Dollar-cost averaging means the buy price of stocks is averaged out over time. You might buy Amazon stocks, for example, today and pay $1500 USD each. Next month the economy might tank and the price could be $900 USD. Then the month after that Amazon stocks might rebound back to $1200 USD. The whole time the price is going up and down, you’re buying $1000 of stocks a month despite the price. Over time the price is averaged out and you get to protect yourself from the huge drops and take advantage of the highs.
You can use this strategy for other assets such as Gold, digital currencies, bonds, foreign exchange, commodities, etc.
You are probably not a professional trader in the stock market. If that is the case, dollar-cost averaging can be a strategy worth considering.
Or do nothing
You can choose to do nothing to. You can refuse to give in to the fear and not make crazy investment decisions during these uncertain times. You can play it safe and stay out of the stock market if you choose. Stocks are not going anywhere — you’ll always be able to buy them.
Final Thought
Stop trying to predict the bottom of the stock market. Bear traps, prolonged economic downturns, upside-down financial markets, and unpredictable events like a second wave of a virus can all wipe you out financially.
Your goal is not to predict the bottom of the stock market.
Your goal is to survive these uncertain economic times, stay safe, invest with less risk, thrive from sustainable investment returns, and enjoy life without too much financial stress.
Nobody can predict what is going to happen with the stock market and that’s your greatest investing advantage.
