Sometimes, it is best to just turn the CNBC and Bloomberg off and stop reading the quotes. Or maybe I should rephrase this. It is always best to ignore the daily or hourly or by the minute barrage of data from the markets. This data does not mean anything. It is not information.
I have tremendous respect for all the chartists and technical traders out there. This is an entire field on its own that tries to impose some sort of a meaning (or orderliness) to what is essentially random stock price movements on a daily basis. The way I see it is that it works at times, but only because a lot of investors believe that it does. It is self fulfilling in many respects. For example, if 100s of traders see a particularly bullish indicator on a chart, and they all rush in to take advantage of this signal, the stock price will surely rise as demand goes up. It works until it works. Then it stops and reverts to the mean.
Smart long term investors leave this short term play on price movements to the professional technical traders and solely focus on the “mean”.
In the short term, the markets are seemingly random, and the stock prices are a result of demand and supply forces acting within the small slice of time. In the long term, the stock prices move on a path that is defined by the value the company creates for its shareholders or the value that the company already possesses. This is the “mean” that all short term trades work to converge the price to. When the price gets too off-whack with the mean (or the intrinsic value of the stock), it creates an opportunity for a value investor to profit from by buying or selling the stock.
Essentially, an investor should focus on estimating the intrinsic value of the stock and make a decision to purchase or not. Once a purchase is done, the investor is wise to ignore the daily flux and all the market noise and stick with the investment as long as the intrinsic value does not decline.
Both technical traders and fundamental investors are essential for the smooth functioning of the stock market. And both can win on the same stock. The question is, what kind of an investor you are?
If you are a long term value investor, you do not have to worry about the traders or even the computer generated trades. They do a great job of creating liquidity in the market.
