Making money in the stock market is a skill. It’s not quite up there with the skill needed to be a brain surgeon or airline pilot, but it’s a skill none the less. The question then is “can you learn this skill?” Chances are you can, but before you do, you’ll need to start thinking a little bit differently than you are used to.
I have a theory that the biggest stumbling block for people learning a new skill, any skill, is that they come into the process with a set of pre-conceived notions which impair their ability to learn and be open to new knowledge. It’s like trying to build a house on a faulty foundation – no matter how beautiful the structure you build on top of it, chances are it’s doomed to fail.
When learning to make money in the stock market, the most basic -- and important -- concept you’ll have to understand is what makes the market move – both up and down. Ask the average person and they will give you reasons such as company earnings, economic data, consumer sentiment, geo-political events, and a host of other things to explain why the market moves one way or another.
And it’s not just individual investors who play this game. Take a look at any of the financial news programs at the end of the day and you will see a host of talking heads confidently pairing up the latest news flow to the day’s action in the stock market.
The reality of the situation though is that the only thing that moves markets, up or down, is the law of supply and demand. If there are more buyers in the market on a given day, it goes up. Conversely, if there are more sellers taking part during the day, then the market goes down.
Why is this so important to understand in order to make money in the stock market? Because making money in the market requires decisions. Decisions on which stock to buy, why to buy it, how much to buy, and most critically, when to sell it.
All the things that individuals and the media use to explain market movements are subjective; things influenced by personal tastes, feelings, or opinions. And since they are so open to interpretation, how can they be valid reasons to influence your decisions? The decision you have to make in order to profit from the markets.
The answer is “they can’t.”
For example, if you accept that the reason the market sold off was because of a geo-political event, how does that help you make a decision? How far will that geo-political event cause the market to drop? And for how long will it impact the market? What will cause the market to discount it? And how does it have anything to do with the individual companies that you hold stock in?
You would have to have an MBA in geo-political economic theory along with a whole team of analysts in order to answer those questions, and even then they would still be based on your own subjectivity.
So the first thing you need to do if you want to make money in the market is accept that the “Why” of the market doesn’t matter. Not only doesn’t it matter, but it doesn’t exist, so don’t waste your time trying to figure it out. Instead focus on the “What” of the market.
Instead of saying “Why did my stock….,” say “What did my stock….”
What did my stock do? It went down. Why? I don’t care. Is it still a stock I should hold based upon the criteria that got me into it? And is that criteria objective and not open to interpretation? And the only real criteria that fits into this objective way of thinking are those derived from technical analysis – the study of price and volume.
Technical analysis is a graphic representation of the “What” that is happening in the market or in a particular stock, leaving out the “Why.” Learning technical analysis immediately removes the subjectivity from the market, leaving only objective criteria – fact based criteria – with which to make your market decisions.
As human being we have an innate desire to pair up cause with effect. It’s one of the reasons we flourish as a species, because we want to solve problems, find answers, and create solutions. Those traits work well for us in objective areas like math and science, but fail in subjective pursuits like art and music.
The stock market seems as if it is closer to science because it deals with numbers, and thus we think the cause of market movements should be objective. But the sooner you realize that figuring out the cause is more of an art, and that the only objectivity can be found in the effects, the better off you will be as an investor.