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Understanding the Stock Market

I've been educating myself in the stock market for the past years, and I have bought and sold stocks over this time. It's an interesting experience, as few things relish mystification as much as stocks.

Here are some of the main misconceptions I see and hear about the stock market:

  1. The stock market should always go up, and something is wrong if it doesn't. The news always sounds worried that the stock market tumbled, or took a hit, or however they phrase it. People seem doom and gloom about it. Sure, it's true that no one wants a recession or major stock price drop, but the stock market going down some is not inherently bad. Down days means that corrections are happening, bubbles are being popped, and new entry points are being established for buying stocks. With down days, good stocks are on sale, so that you can buy low and sell high.
  2. There is a magic system out there that will play the market perfectly. There is no magic system. The future is unknown. Will it rain tomorrow? We can guess, and we can maybe get it right and maybe get it wrong, and the stock market is the same way. It's about probabilities and expectations, as well as what you're comfortable with. Are you willing to lose 20%? Are you willing to only gain 2% a year? There is inherent risk in owning stocks. But with our retirement system no longer being pension-based but market-based, owning stocks in some fashion is inevitable. So we must learn about it and take some risk.
  3. The stock market is too complicated, and is only for the pros. Jim Cramer is a big help here: the stock market is actually not all that complicated. Stocks go up and down in price; prices go up when buyers expect the company to make more money than was previously expected, or when a dividend is announced. It's all about expectations. Rumors that iPhone sales are slowing will send Apple's stock down. Changing expectations of how much money Google will make this year can send its stock up. The simplest way to benefit from the market is to buy low and sell high (there are other ways, but they are riskier and more complicated). If you think that Apple is going to announce some great new products that will change expectations about its upcoming profits, then on a down day go buy some stock. If the stock goes down, decide whether to hold or buy more. If it goes up, decide when you want to sell. What's hard about the market is not understanding it, but taking the risk. Buy low and sell high sounds easy and great (almost too easy), but try it and you will see how hard it actually is. We'd rather buy high (when the company is riding high and expectations are great) and hope it goes higher. But when the company stumbles, we panic and sell low, and thus lose money. Buying low is staking a claim on an unknown future, when others have decided against a stock. It's inherently contrarian. Then, as people pile on and the stock goes up, you must decide if you want to sell. To sell when things are good is feels wrong, as the hope is that things will stay good. But at some point, the stock WILL stumble, and then decline, and it is then you will feel like selling. You will see your stocks go down in value, and you must choose carefully how you respond. Doubling down may be the best choice after all, but it's definitely unsettling!

The market enjoys its mystifications, and wants you to trust it. Don't. Rather, be an active participant in your own future. 

Theology is "the study of nothing"

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