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Stock Market Investors Warned of Time Relevance Trap

Recent Events May Seem More Important than History or Common Sense

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Picking great stocks is really about identifying great companies. Finding a great company is only part of the story of course.

Investors in the stock market must be able to buy the stock at a price that allows for future profits. In other words, investors must not only identify a great company, but also must discern an intrinsic value of the stock and buy below that value.

This strategy is the closest thing to a sure bet on Wall Street.

However, it often requires patience to wait until the stock's price is at that point to make the purchase attractive.

Patience is not the only virtue of the long-term stock investor. A clear head and firm plan are needed to avoid being swayed by events or emotions.

While stock investors may want to think their investment decisions are based on pure logic and reason, we all know that's not always the case.

A variety of factors beyond fundamental or technical analysis shade our decisions.

The two emotions that receive the most attention are fear and greed.

Fear panics investors into selling a just the wrong time and greed urges us to buy at just the wrong time.

By focusing of identifying great companies rather than great stocks, the long-term investor can build a solid case for buying the stock of a great company at a great price.

Fear and greed shade and distort this strategy if investors are not careful.

However, there are other factors stock investors should consider.

One of the most influential non-analytical forces convinces investors that whichever direction the market is moving at the moment is the direction it will continue to move.

If the market takes a swing up for several days, investors often assume it will continue in that direction despite historical and analytical evidence to the contrary.

For example, after the market has marked a significant upswing, it is probable that investors will take profits and their selling will halt and reverse the advance.

This is not to say the market won't resume its upward swing after a pullback, but there is no rule that says this must happen.

The reverse is true when the market slides significantly. Some investors will assume that is the market will continue moving down.

However, it is often the case that prices will drop to a point where stocks become a bargain and investors step in to grab some values.

Their buying will usually reverse the trend, at least temporarily.

What is happening is a factor called time relevance, which says recent events are more important than historical ones.

Time relevance creates an atmosphere where fear and greed can breed and grow.

During the dot.com boom in the late 1990s, there was a stampede, mainly by novice investors, to cash in on the easy money to be made in tech stocks.

Companies with no real products or services, no revenue, obviously no earnings and the barest threads of a business plan raised millions if they could put together a flashy PowerPoint presentation.

There was a sense that the sky was the limit for market indexes. When the dot.com bubble bursts, it left many more losing investors than winners.

Likewise, when the markets melted down during the financial crisis of 2007-08, many investors cashed out of the market fearful that there was no apparent bottom in sight.

In both cases, there was a broadly held assumption that the market spiraling up (or down) was likely to continue in that direction.

There is some truth to the idea of recent events having more relevance that past actions, however don't let your short-term memory override your logic.

The point for investors is don't use the direction of the market as a sign it will continue moving in that direction indefinitely.

As the label says: "Past results are no guarantee of future performance."

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