Stock prices are a function of human emotions – fear and greed. Greed causes investors to buy more and more shares, which pushes the stock's price higher and higher. Eventually, the stock becomes overbought. It may still move higher, but on lower and lower volume – a classic signal that it might be peaking. As an old investing saying goes, bulls make money, bears make money and hogs get slaughtered.
• You can't beat the market, so just buy index funds Though index funds, which own stocks reflecting those of certain market indexes (such as the S&P 500), can be an inexpensive way to gain exposure to an entire index, does it really make sense to faithfully hold them during a bear market as they continue to fall in price? There are many studies that show you this works over a 20- or 30-year time period if you just stay invested. Like so many investment theories – they are just that – theories, not reality.
These studies refer to investment returns, not investor returns. For investors to get all of the benefits, they have to be in these funds for the entire period studied. If only we should live so long — or have the forbearance to take pain with no gain for long periods. Many investors eventually sell out at some point – and it's usually near the bottom. Why not put a limit on how much you are willing to lose – say, 10 percent? You'll sleep better knowing that you've protected your capital and will live to fight another day. Besides, is your goal to outperform the market by half a percent, or is it to earn returns without losing sleep?
Big financial services companies like to communicate these notions because they are simple (I say simplistic). They are presented as indisputable, time-honored investing maxims. Well, they may be time-honored, but they are easily disputed by anyone who tried buy and hold through the tech crash of 2000 or the financial crisis of 2008-09.
This column is the opinion of the author and in no way reflects the opinion of ABC News.
Byron L. Studdard, a CERTIFIED FINANCIAL PLANNER™ practitioner, is founder and president of Studdard Financial, LLC, a financial advisory firm in Sarasota, Fla., dedicated to helping clients build wealth, protect it and pass it on to future generations. Studdard is listed in the Guide to America's Best Financial Planners (published by the Consumers' Research Council of America, an independent research organization). He can be reached at Byron@studdardfinancial.com. If you have a question for him, send him an email and he will try to answer it in an upcoming column.