by Schwab Center for Financial Research
The stock market is a dynamic and occasionally confusing place. Each day, professional traders, big institutional investors, algorithmic platforms, passionate amateurs, and more meet to have their say on how much they think each stock should cost. In a sense, each tick in a shareās changing value is a shift in the consensus arising from a huge virtual debate between clever strategists, cold calculators, and gut reactors.
And yet, busy as all that is, patterns exist. Conventional wisdomāeven when expressed in a homely proverbācan occasionally serve you as well as the super computers brought to bear on the market. Of course, that doesnāt mean you should outsource all of your trading decisions to slogansābut even the pithiest of sayings can contain enough wisdom to help guide your research. Weāve gathered five of the more reliable ones here.
The trend is your friend
Some traders believe that smart investing comes down to behaving differently than everyone else in the market, and bucking trends where they can. The problem is that price trends are reality, representing the collective actions of all market participants, and rebels can risk getting run over.
When the broad market is trending higher or lower, so are most of the stocks in it. Rather than fighting the trend, acknowledge the direction of the overall market and plan your trades accordingly. There are limits, of course...
Be fearful when others are greedy and greedy when others are fearful
Uptrends and downtrends can be long and sturdy, but at a certain point the market will change direction. Timing these reversals is difficultābut when the sentiment toward a particular stock gets to be too strong either in favor or against, then skepticism may be in order. During these times, think like a contrarian and donāt become complacent.
Donāt try to catch a falling knife
This refers to the urge to buy a stock that is falling sharply. Just as it is dangerous to try and catch a knife as it falls to the floor, it can be just as risky to buy a stock during an aggressive sell-off. If your analysis of a companyās fundamentals indicates that regardless of the fall, now is a good time to buy its stock, you should do so. But donāt buy just because it appears to be āon sale.ā Weāve all seen that item in the store that is marked down 10% and three weeks later is marked down 25% or more. Purchasing these āsaleā items too soon can be bad for your trading account.
Buy the rumor and sell the news
The idea behind this saying is that traders can position themselves to profit by buying a stock when an anticipated bit of news is still just a rumor. The potential impact of rumored announcements tends to get baked into a stockās price before any announcements are made. If the rumor turns out to be true, then it will already be reflected in the price. If the rumor isnāt true, then the trader can try to lock in a profit by selling. In short, stocks often move on speculation and then adjust when the news is official.
Bull markets climb a wall of worry
This is another news-related saying, this time regarding periods when the market continues rising even as some negative financial or economic news causes disquiet among the broader public. How can the market continue moving higher in defiance of prevailing sentiment? In short, buyers continue entering the market, pushing it over what otherwise might be a hurdle to further growth. If youāre waiting for everyone to agree on the market, you could be waiting for a long time. Markets can go up when people are still queasy, and fall apart during seemingly good times.
Proverbs to remember
The bottom line is that traders keep these sayings alive because they capture something about how people relate to markets, and how markets affect people. If they didnāt, nobody would use them.
The stock market isnāt nature, with immutable physical laws governing how things work. But it does have conventions, and sometimes those conventions end up working just as well as laws.
