Oh, the Mockery

You have to wonder whether there's a better way to manage your nest egg

By Alex Roslin
Thursday, January 17, 2008
The Montreal Gazette
Business Observer

Is it just me, or are the markets acting crazier than a zombie in a horror flick?

I bet many readers looking at their investments are thinking the same thing: Surely, there's got to be a better way to manage my little nest egg.

Here's one common investing mistake I've made from time to time. Maybe you have, too.

It all starts with some gushing news about how China or Florida real estate or some other ripping market has zipped up, up and away, straight to the heavens, leaving you wretchedly back on boring Earth with your miserably languishing investments.

If only you had realized months ago the lofty potential of this on-fire market, like everyone else on the blessed planet somehow did, why, your toes would already be sinking into the soft white Caribbean beach, instead of hiding in wool socks and boots.

So what do you do? You probably jump in anyway, of course. Maybe, just maybe, you tell yourself, egged on by bullish analysts who say the market is headed far higher, you can still catch some of the ride.

Then what happens? More often that not, the market sells off sharply. But don't worry, the analysts will say. It's just a minor correction, a sorely needed breather before the market flies to even more rarefied heights.

In fact, the selloff is really a godsend, a chance to load up even more at a lower price. What luck! Investing is so easy.

So you buy another piece of the action. At some point, though, it dawns on you the "pause" is looking more like something else -- a true correction, a rout even. You avoid the newspaper and TV news, not wanting to learn the bloodbath has worsened.

You're soon sick with self-doubt, paralyzed into indecision. Should you dump it all? Should you hold because the selling eventually must end, must it not? Or maybe you should even add to the doomed investment, seeing as how it's now so ridiculously cheap?

Eventually, you reach what traders call the "puke point." You just need the horror to end. So you sell.

Of course, you know the rest. Here, precisely, is when the carnage does stop, and the market joyfully bounds back. Oh, the mockery. You wonder if the raison d'être of the markets is to mess with your head and steal your last penny.

Sound like a familiar scenario? If so, take heart. You're not alone. We all know we should "buy low and sell high," but in reality, we often find ourselves doing exactly the opposite: buying high and selling low.

This dynamic has, in fact, been the very fuel of the markets for centuries, since well before modern history's first major speculative bubble - Holland's "Tulip Mania" of the 1630s, when the price of a single tulip bulb shot up to as much as 40 times the average yearly income, then crashed, devastating the Dutch economy for years.

Today's investors, seemingly better informed, still make the same mistakes. The dot-com disaster is one example. Now, it's happening yet again with the U.S. real-estate catastrophe.

It reminds me of what Frank Borman, CEO of Eastern Airlines, once said: "Capitalism without bankruptcy is like Christianity without hell." (Eastern went bankrupt three years later.)

Curious about all this, I recently studied data, available from the U.S. Commodity Futures Trading Commission, on how small-time traders perform in the futures and options markets.

I found something curious but sad. The crowd isn't just wrong in the markets; it's so consistently wrongly positioned in the markets, you can reliably make good money doing the opposite.

I found you could have beaten buying and holding the NASDAQ 100 index by 10 times since 1995 if you had bought the index when the small traders hit specific extremes of pessimism and sold the index short when they got excessively bullish. (Selling a security short is a way to make money when it falls in price.)

If you're wondering how the small traders stay solvent, the answer is most probably don't for long. But history shows there's always a new generation of gamblers lining up to feed their offerings into the hungry maw of our free-market system.

So what can you and I do? I think it's important to educate ourselves about how the markets really work and try to learn something from our mistakes.

As author Stephen Covey wrote, "If we keep doing what we're doing, we're going to keep getting what we're getting."

But like a zookeeper feeding a tiger, never forget your humility. After all, history is against you.