On any given trading day on the New York Stock Exchange, two billion to six billion shares exchange hands. Who are all these people, why are they buying and selling, and how do they know what to do?
In many cases, the reasons are not what you think.
A pension plan may follow an asset allocation strategy for a portion of its investments, and at the end of the quarter, they need to rebalance. If stocks are down enough, they automatically buy more. Their buying reflects nothing about their current market sentiment and everything about the discipline they follow.
Yes, you may think. That sounds logical. Maybe you should rebalance now, which means adding more to the things that are down.
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On that same day, a mutual fund may get redemption requests as people get scared and pull out of the market. Regardless of whether the fund manager thinks the market will be going up or down, the fund may be required to sell shares to raise cash. The news reports on the number of redemptions happening. “People are going to cash,” you hear. Maybe you, too, should sell and wait this out.
Then you hear about a giant investment advisory firm and read their white papers. Hmmm. They follow a valuation approach based on their outlook over the next seven years. They are buying because price-to-earnings ratios of an asset class look low enough that the long-term potential for returns appears attractive. That sounds smart. Perhaps you should buy. But then you find out they are buying emerging markets and small-cap value. Oh, that sounds scary. Maybe you should hang tight.
Meanwhile, a hedge fund is selling positions to raise cash to pay down debt because it borrowed to invest. You may not know the reasons why, but you hear that a big-name money manager is selling. If they are selling, well, shouldn’t you be too?
Then there are the day traders, looking at charts and graphs and applying what is called technical analysis. A golden cross pattern, you hear? What’s that mean? You look it up on the internet. It sounds like a buying signal. Yes, you think, “I should be buying.”
Then there’s that newsletter you read that focuses on macroeconomics. Unemployment will be skyrocketing. GDP will be down. People are saying it will be bad, really bad. Shouldn’t you be selling?
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But wait, then you read that the stock market is a leading economic indicator. The market dropped substantially as it priced in the recession. Is it now looking forward, pricing in the recovery? Did you miss the bottom? Maybe it’s not too late. Perhaps you should be buying.
Then you’ve got John Smith, who just got his stimulus check. He’s never owned a stock in his life, but he heard this tech company was coming out with something. He opens an account and buys 100 shares. On that same day, his brother Sam loses his job. Sam has a small stock account and owns shares of that tech company. He needs cash to tide him over while he’s unemployed, so he sells.
And you’ve got Sally Sue, with a steady paycheck and with each paycheck she contributes to her 401(k) and keeps buying. And Mary, who receives an inheritance. She sells and uses the cash to buy her dream home.
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Yes, on any given trading day, billions of shares exchange hands. And most of them have a good reason. The need for cash drives some of them. But for those who don’t need the money right now, how do they know what to do? Most of them have extensive training.
The long-term investors have a discipline they are following. The day traders have a strategy they use. The institutional investors base their decisions on an outcome they want to achieve over a defined period. And time frames can vary depending on who’s doing the investing. It may be a few hours for a day trader, a calendar quarter for a hedge fund, or 30 years for a pension plan.
If you’re not sure whether you should buy or sell, maybe you are asking the wrong questions. What are you trying to achieve, over what time frame, and using what investment approach?
If you don’t know the answers, sitting on the sidelines is probably wise.
Source : MTV
