Thursday, March 29, 2012
Most people I talk to about their investment portfolios seem to have at least one thing in common. They have an investment they purchased some time ago which is just sitting there, not contributing to their returns. Usually, it isn't hurting them any longer, either. That is because it sank in value, big time, a long time ago. Now, there it sits - a reminder of that big loss, and too small and unimportant to do anything about - not even sell it. Why bother to sell it? Perhaps, one day, it might actually appreciate in value.
We can hope all we want, but it makes for a poor investment strategy. Sure, the damage has, largely, been done, but why not put that money into something useful? The reason is simple. We raise money by selling the investments that are in the black, and we hold onto the ones which are in the red. Perhaps it provides a little insight into hoarders who can't bring themselves to throw anything out after suffering a catastrophic loss in their lives.
Back To Even
We all have the same tendencies. When we aggregate these tendencies into market-wide behaviours, trends begin to emerge. Technical Analysts refer to certain points on the chart as "resistance", and "support". These points exist on the charts for the very reasons I have just described. If a large number of people bought the same investment at a level where it started to lose value, that point will later become a point of resistance, since human nature is to sell as soon as we get our money back. Normally, we don't care how much higher it could go - we were wrong once, so better to take the money and not get greedy, thank you very much.
Depends On Your Viewpoint
When an investment drops to a level where a large number of people previously watched it reverse, they might even be inclined to buy more, this time around. It is like the investment is now on sale. These become areas on the chart where support for the price is established. Once violated, support levels can turn into resistance, and resistance levels into support.
When To Buy
Technical Analysis is not just a bunch of lines on a chart. There are good reasons to explain why things happen the way they do. These are only two very basic examples. Personally, I don't rely on Technical Analysis to determine what to buy - I use historical data and earnings forecasts to do that. I use Technical Analysis to tell me when to buy once I have determined it to be on sale. This doesn't work so well when buying commodities, but there are other ratios we can use to see, historically, if they are cheaper than normal.
Long story short - I ask myself, "If I didn't already own this loser, and knowing what I know today, would I still buy it?" If the answer is no, then it is fairly obvious it has outstayed its welcome. Time to move on and look for a better use of whatever is left. Otherwise, it brings to mind the definition of insanity which refers to doing the same thing over and over, again, each time expecting a different result.
Any such losers in your portfolio? Nortel, anyone?