During a bear market, when prices are falling steadily over a longer period, you'll often hear investors warning not to try 'catching a falling knife'. But how do you know when the knife has hit the bottom? Photo: Frank Rumpenhorst/dpa
Sometimes it sounds so simple, playing the stock market, given such advice: "Don't put all your eggs in one basket", "Holders of interest-bearing security sleep soundly", or "Buy shares, then take a sleeping tablet and when you wake up you'll be rich". These and many more investment "tips" exist, the question is, how reliable are they?
For Jessica Schwarzer, a finance journalist and author, such adages are always a source of joy. "Those are often pithy sayings from well-known investors who describe the stock market in flowery terms," she says, naming two internationally famous investment gurus, Andre Kostolany and Warren Buffett.
Like farmers' proverbs, the tips summarise the patterns which investors have observed on financial markets – or say they have. Some are funny, such as: "The biggest enemy of an investor is staring back at them in the mirror every morning."
But Max Schmutzer, an investment expert for the German consumer affairs lobby Stiftung Warentest, warns that such sayings are no replacement for a stock trading strategy.
"Often these bits of wisdom apply only to partial aspects of events on the market. Some are even contradictory because they are targeted to different types of investors," Schmutzer said. And other adages simply are not true.
However, many do have a kernel of truth. Those who ponder such sayings will not get any clear investment instruction to act on, but yet something to think about. Here are six of them:
'Don't try to catch a falling knife'
If you do, then you'll cut your hand. So it's better to wait until the knife is on the floor and then pick it up without any danger. On the stock market, it means that investors can make a bad investment if they buy a share after it has fallen in the hope of having gotten a real bargain.
But is the fall over? Or will it continue – if so, then the stock purchase can lose value. So you have to wait until the stock has really hit bottom.
"The problem with this stock market wisdom is that investors can scarcely estimate when prices have really reached bottom," Schwarzer says. So it's best not to speculate. Better to spend some time analysing the company and the reason for its plunging stock price.
'Buy stocks, take sleeping pills for 20 years, and stop looking at the papers. After many years, you will see: you’ll be rich.'
This wisdom came from Hungarian-born investor Kostolany (1906-1999). It argues for investing for the long term. "However, this is often falsely translated," Schwarzer says.
"It's not about a stubborn buy-and-hold. Instead it is a plea for long-term investing while cautioning not to be overhasty while trading."
Investors should now and then check their stocks' positions, she said. Especially with regard to individual shares or various mixtures, it is important to regularly check how the portfolio is developing.
Kostolany's advice is backed up by various studies. For example the stock analysts Morningstar in a study found that decent yields can be achieved only in very small time frames.
So it is of decisive importance to be invested in the market at those moments. Just when those will be, nobody can predict. But those who invest for the long term will be there for the market upswings.
'Sell in May and go away'
This is only the first part of the adage. The second part: "But remember to come back in September."
On the stock market these days, this is no longer applicable, Schmutzer points out. "This goes back to the analogue times, when stock traders would head off for extended summer holidays."
That was when demand on the financial markets was thin and so share values would fall until September when the holiday season was over.
"Today, with electronic trading, this no longer is true. Those who always follow the rule on average buy back the papers more expensively."
'Back and forth will empty your pockets'
This adage as well has lost its relevance, according to Schmutzer. It's a warning against trading too often. Up till a few years ago, high transaction fees weighed strongly on trading success.
But since there are now traders who charge only minimal fees in buying or selling securities, this cost factor often no longer applies.
Still, you should keep this rule in mind, the analyst advises: "It also namely warns against chasing after every hype. Many investors overestimate themselves when they think they are smarter than the market."
'The trend is your friend'
This is a saying that Schwarzer finds difficult. It concerns a technique in which investors analyse the movement of share prices and find trends with which to predict future price developments.
"Looking backward, trends are always easy to see. But to rely on them is something you shouldn't do," she said.Kostolany also thought little about this approach: "When I turned the chart around and arrived at the same result, I noticed that the technical analysis doesn't work."
Schwarzer recommends that instead of charting technique, you should come up with a long-term strategy. "Investors should think up their own rules for different market phases and then stick to them," she said.
'Sell on good news, buy on bad news'
Those following market developments will often see behaviour by investors which at first glance appears to be illogical. If a company reports good figures, its share price drops.
Schwarzer explains: "This is because it's the future that is being traded on the exchange. Sometimes, behind good quarterly results, there is some hidden news that the growth will soon be over."
On the other hand, behind bad news, such as a company embarking on a cost-savings effort, there may be hope for an upswing soon. As such, this one bit of stock market wisdom has a kernel of truth.
"Investors must however look deeply and see exactly what is behind a company's announcement," she said. Simply to buy shares on bad news can turn out to be the wrong decision. – dpa
