The price of every stock is made up of two elements:
- “Investment value” measures the worth of all the cash a company will generate now and in the future.
- The “speculative element,” is driven by sentiment and emotion: hope, greed and thrill-seeking in bull markets; fear, regret and revulsion in bear markets.
Sound familiar? This is why the simple thought of trying to “beat” the market is not. Most actively managed mutual funds can’t outperform their benchmarks. If they can’t do it, the Average Joe shouldn’t assume that he can, either. In the short-term, the herd behavior of the pros makes it a Herculean feat to take a winning bet against the “speculative element” in a stock’s price. [Is there a way to cope with risk in the market this year?]
This is why it’s important to have a strategy, such as trend following. By watching market trends using the 200-day moving average, and by having a disciplined strategy that you stick to no matter what the herd is doing, you give yourself the opportunity to participate in any potential long-term uptrends and you strip away the emotional aspect of investing.
This is also another case for ETFs. By investing in a basket of shares that track a sector or a country, or the broad market, you can avoid the radical swings that a single stock can take and enjoy the benefits of lowered volatility. [Try setting a stop-loss, to keep losses minimal.]
For more stories about trend following, visit our trend following category.