Frequently Asked Questions on Investing (Part 2)

This is part 2 on frequently asked questions I encountered. 

Question: This stock has been falling for the past week and is at its lowest point this year, is it a buy now?

Question: This stock has rose 50% since the beginning of the year, and I hear others saying it will go even higher.. should I buy?

Question: Should I buy the dip?

These are classic FOMO (Fear of Missing Out) questions.

In Part 1 posting, I discuss 2 important things to do before investing:

1) The objective or goal of the investment must be clear.

2) The tools available to achieve the objective or goal must be understood.

Now I shall discuss what we can do about emotions and how to keep emotions in check when we invest (especially in the stock market).

Mr Market reacts emotionally in short time frames (Days to Months). As the time frame stretches longer (Months to Years), emotions play less of a part and fundamentals come into play. For really long time frames (Decades), fundamentals will be the main driver. 

Depending on your investment style, you can either "average out" the emotions of the market or capitalised on the emotions of the market.

For short term investment, it would be more sentiments and technical analysis to determine the entry and exit price. If the technical analysis is done correctly, the entry and exit price should already be known. Traders would embrace volatility as a wide fluctuation in prices means their earnings can be huge, but so can their losses if they are on the wrong side of the trade. That is where stop losses comes into play. Again, I am not a trader, so do follow traders out there who are gurus in this area and can explain it better than I do. Professional traders always have a game plan (entry and exit strategies). This allows them to take the emotions out of the equation and execute trades based on the best risk reward returns.

If you are medium to long term investors, short term fluctuations do not matter. Conviction is most important. The investor should have researched and built very strong conviction on a few companies and decide which of those companies are worth holding. Typically, a disciplined investor will not go all in at once, but spread out their entry into a stock in multiple tranches. For example, if they have $10,000 to invest in 1 company, they might only allocate $2000 for the first tranche. Then if the price falls 10%, they will allocate another $2000 to buy more shares. If the price falls another 10%, they might then enter $3000 to buy. And if the price falls another 10%, they will allocate another $2000 etc. This is dollar cost averaging or DCA. Notice that the entry price is already decided. The game plan is there to reduce risk and improve returns.

Regardless of whether you are a short term or long term investor, having a game plan like that take the guesswork out of the equation. Most importantly, it takes the emotion out of the equation. Entering and exiting a position based solely on emotions is a terrible idea. It will almost always guarantee a loss, unless luck is on your side. Relying solely on luck is never a good investment strategy. 

Remember, always have a game plan to minimise risk, maximise returns, and remove the emotion. Always stick to the game plan and never FOMO. If you miss one good deal, let it go. There is always a good deal around the corner.

@TigerStars