Most investors have a need to know WHY an investment will go up or down in price. As a result, most of the analysts you see on the financial networks tend to spew out information regarding the fundamentals of the economy, individual stocks and commodities. Unfortunately, most of this analysis doesn’t do the investor any good.
For the individual investor, it is simply not possible to know everything there is to know about an investment when it comes to fundamental information. Therefore, it is necessary to form an opinion based upon the information at hand. However, very smart investors will often come to a completely different conclusion from one another.
Consider the current case of Herbalife. Hedge fund manager Bill Ackman insists that Herbalife is a pyramid scheme, and as a result has been selling the stock short. He has been in a war of words with well known billionaire investor Carl Icahn, who it was revealed this morning on CNBC, has increased his stake in Herbalife. This morning, Herbalife stock is up 20%.
Who is right? The price is right! The single best indicator of the value of any investment is the current price. If the price is rising, it simply means that demand for the investment is greater than the supply. If the price is falling, then demand is weak relative to supply.
Most investors are taught to buy low and sell high. This means they need to find value where others don’t see it. Yet, as demonstrated above, very intelligent investors can often come to very different conclusions. Therefore, it is necessary to ask oneself…what makes me smarter than the next guy?
Trend followers are not concerned with fundamentals. Trend followers buy high and sell higher, or sell low and buy back lower. Jesse Livermore is probably the first well known trend follower discussed in investment books. William O’Neil, founder of Investors Business Daily, highlighted this strategy too, as did Nicholas Darvas.
Over the last few decades, the most long lasting, successful traders in the world of commodities and futures have been trend followers. These traders have trounced the performance of the S&P 500, and thereby have substantially outperformed 80% of the mutual fund universe. Pure trend followers don’t bother trying to analyze fundamental information. The best indicator in their mind is the price of the security itself.
What I find most common among individual investors is the need to be right. They will persistently stick with an investment even as the price works against them. Apple is a perfect case in point. When it fell back to $600 from its high of $700, many people thought it was a simple correction, since many analysts forecast the stock to go to $1,000. Now the stock is mired in the $460 range. While the downtrend may be over, and now may be a great time to buy, other stocks have been going northward in price.
If you absolutely need to have a fundamental reason to buy or sell a security, wait for confirmation from price itself. The name of the game is to make money, not to be right.