Respect the lines (The Financial Athlete #47)

Lines are very meaningful in sports. Without lines in sports, chaos would ensue. Lines give order to the game. The first runner to cross the finish line in a race is the winner, but to cross the side line is a lane violation and would disqualify the runner.

Lines mark boundaries of in and out of play. Just inside a line, a baseball batter hits a home run. Just outside this same line, it’s a foul ball.

Lines delineate the gridiron from the sidelines to the endzone and in between from the 1 yard line to the 50 yard line midfield and down the second half of the field.

Lines play a tremendous role for technical analysis which is used for stock trading. A useful tool of technical analysis for investors are trend lines, which indicate the direction of the price trend of a stock.

The first lesson for investors of stocks should be watching the directional or trend line of the stock price. Even a small child easily can recognize the direction of lines, whereas it may take years to become financially literate.

If the trend line slopes downward, be weary of buying. Better to wait for a base to form or a price reversal before buying. Do not be stubborn with the intent to buy at bottom. Extremely rare or non-existent is the person with an uncanny ability to consistently call bottom correctly.

If you buy at what you believe to be bottom but the price continues to descend, what will you do? The tendency of an average investor is to buy more at a lower price. If it drops further and further, the average investor continues to accumulate. Savvy investors mock this process of averaging down as “catching a falling knife.” Keep in mind the objective of investing is high returns, not to try to buy at bottom. Fighting the trend line more often leads to negative returns and imbalanced portfolios rather than riches.

There is wisdom in the common refrain of “Do not fight the tape!”. Respect market forces. Sellers may know more than you. Investors cannot see what may lurk behind the publicly disclosed information.

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