Most of the beginner investors have intuitive assumptions that don’t match the reality of the markets. These intuitive assumptions are part of human nature. We need to let go of these assumptions to improve our results as investors.
1. A good investor must know which asset is going to appreciate or depreciate the most.
It’s impossible to know which asset is going to appreciate or depreciate the most. Therefore, it doesn’t make sense to invest all of our savings into a single asset. Holding a diversified portfolio is the best strategy for the retail investor like you and me.
The only exception to that rule are the fiat currencies such as USD and Euro. We know that they will depreciate over time, because it’s the official policy of central banks and governments.
2. A good investor must know the top and bottom of an asset.
It’s impossible to know the top and bottom of an asset. The price of an asset can go lower even if you think it is already too low. In other words, “don’t try to catch a falling knife.” The price of an asset can go higher even if you think it is already too high. Rules such as “never buy at a historic high” don’t reflect the nature of stock exchanges. Buying at historic highs worked well in many cases.
3. A good investor must make a lot of profitable trades.
It’s impossible to know which assets are going to appreciate or depreciate. It’s impossible to know how much an asset is going to appreciate or depreciate. As a result, the more we trade, the more mistakes we are going to make, and the more money we are going to lose.
I made the most profits from buy and hold positions. I missed the most profits from selling too early. Therefore, my motto for investing is “buy and forget,” until I need the money or until my investment hypothesis doesn’t hold anymore. For example, when I buy a stock because it’s a value stock and it’s already overpriced according to the metrics I follow, it might be the time to sell it.
4. Markets are rational and they price all assets correctly.
Markets are made by humans. Humans are not rational all the time. Therefore, markets are not rational all the time. In the short term, markets can behave irrationally, just like the crypto-bubble we have been experiencing lately. In the long term, markets are forced to behave rationally, because there aren’t infinite resources to feed the irrationality. This happens through corrections and crashes. Don’t bet on it that the markets will correct themselves quickly. This can take a lot of time, more than you can endure. For that reason, it’s wise to avoid betting against the markets and taking short positions.
5. One can make profitable trades based on news and opinions.
Most of the news are already expected and factored in the prices. Therefore, they don’t move the prices that much. The news that move the prices move them so fast that it’s impossible for you and me to take advantage of them.
If you have an opinion about an asset and you’re right, there are probably a lot of others having the same opinion and your opinion is already factored in the prices. If you’re wrong, your opinion is going to lose you money. In both cases, your opinion won’t make much money.
The only exception to that is when you make a thorough research on stocks that are out of the radar. For me, those are the small cap value stocks. They require a lot of research to find. Once I find them, I formulate an investment hypothesis and hold on to them until I need money or the hypothesis doesn’t hold anymore.
6. Buy stocks of good companies to make profits.
I don’t aim to buy the stocks of good companies. I can’t make any money buying the stock of a good company if the stock is already overpriced. I aim to buy underpriced assets. I can make money buying the stock of a mediocre company, if the stock is underpriced.
7. You can predict the future by looking at price charts and technical indicators.
I don’t believe in technical analysis. It’s a fallacy of our brains to look at price charts and see patterns. It’s a greater fallacy that the same patterns are going to repeat themselves in the future. This is actually an extension of the irrational assumption #5, “one can make profitable trades based on news.”
Price charts are public news. Everybody knows them. If they were useful, everybody would use them. If everybody tried to use them, they would be useless. As a result, technical analysis is useless. You’re better off investing in an index fund every month than wasting your time with technical analysis.
You might think that these assumptions being irrational is bad news. You might think that these assumptions are your only way to make money investing. You might think that I’m pessimistic for calling these assumptions irrational. On the contrary.
These assumptions being irrational is good news for us. It takes a lot of stress away from investing. We know that we can’t predict the most profitable asset. We can’t predict the most profitable time to buy and sell. We can’t make money from the news, technical analysis, our opinions, or picking stocks. At the same time, we know that our savings in fiat currency are going to lose their value over time. The best strategy to act on these assumptions is to build a diversified portfolio over time. That also saves us a lot of time to follow the news, thinking about the markets, and doing technical analysis.
If you want to invest actively and if you have the time and willingness to do your homework, we also know that small cap value stocks have a higher probability to beat the market.
This post is for information purposes only and not intended to be investment advice.
Software developer with a Ph.D. and 15 years of experience. I write daily on personal development and life lessons. Sign up to my email newsletter to receive a weekly overview of my latest content on personal development and life lessons.