Think of Investing in Stock Market as Game of Tug of
War
Buy what’s going up and sell what’s going down - If
it were only that easy
By Jeffrey D. Voudrie, CFP
Aug. 22, 2008 - A novice investor recently asked
me, “Why don’t you just buy what’s going up and sell what’s going down?”
If it were only that easy, we’d all be millionaires! Read on to learn a
simple analogy that seeks to explain the underlying forces that move the
markets.
Think of investing in the stock markets as a game
of tug of war. We all remember playing this game in gym class, with
people pulling on either end of a rope, with a flag tied in the middle.
The goal is to get the flag to your side as quickly
as possible, and of course, to embarrass the other side by your superior
display of strength. Of course, it didn’t always work out that way and I
have been on the side of the falling team more than once!
This is how investing works in the stock markets.
We often think that the value of a stock is based on the company behind
it, but that is only partly true.
Think of the company as the rope in a game of tug
of war. It’s not just the quality of the rope that will decide which
team wins, it’s the players competing on each side.
On one side of a ‘stock’ rope, you have investors
who believe the stock is going up in price. On the other side is another
group of investors equally convinced the stock price will go down. The
side that puts up the most money will determine the direction of the
stock price.
Unlike in real tug of war, the players in the stock
market can change the amount they have invested and even the side they
are on at any time. Some players might change several times in a day.
Others might stay on one side for years.
This switching of sides is what results in huge
swings in the stock price. If one side of the rope becomes overloaded,
then they have the power to quickly pull the rope their way. If you have
a lot of people and money on one side it’s not going to be much of a
contest.
In the real game of tug of war, the game is won
once the flag moves a set distance. Then both sides quite and move on.
The stock market tug of war is much more fluid. Players can come and go.
Some might quickly take their profit or cut their loss short. Others may
wait until it looks like one side has won before joining the game on the
opposite side.
Moreover, each player may have a different strategy
that determines what side they play on—or whether they play at all. Some
focus on the quality of the company (the rope). Others look at the
statistics of what’s happened in that tug of war in the past. And there
are some that just seem to walk up and pick a side without any rhyme or
reason.
Outside events also play a role in the quality of
the rope and the decisions of the players. There might be a hurricane
affecting the oil supply. The expected outcome of an election could
impact regulation. Housing prices can go up or down.
The decisions made by professional players have a
much greater impact on the outcome of the game than do those of
individual investors. That’s because they have a lot more money to
invest. If all the professional investors switch to the same side, the
individuals on the other side are going to get embarrassed!
Looking at a single game of tug of war allows us to
get a general understanding of the underlying dynamics involved in the
movement of the price of a stock. The movement of a market or a market
index is really the sum of all the underlying battles taking place.
The S&P 500 index represents the result of the tug
of war occurring in 500 specific companies. The Dow Jones Industrial
Average represents 30 select companies.
Successful investing isn’t solely about choosing
which rope, but also choosing the right side. And it’s vital that you
take into account what the other players are or will do. You won’t
always get it right (nor should you expect to), but understanding why
markets move will help you make more logical and informed investment
decisions.
If you have a specific question or would like more
information, give me a call toll-free at 1-877-827-1463 or you can also reach me by email at
jeff@guardingyourwealth.com.
I will answer your financial question FREE.
About Guarding Your Wealth:
“Guarding Your Wealth” is a
nationally syndicated weekly personal finance column written by Jeffrey
D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group,
a private wealth management firm that employs sophisticated proprietary
strategies designed to protect and grow its clients' investments. Visit his website,
www.guardingyourwealth.com to read past articles under the Guarding
Your Wealth Article Archive that may not have appeared in
SeniorJournal.com.
Guarding Your Wealth for Seniors, on
SeniorJournal.com, is
a collection of columns by Voudrie that deal with issues of particular
interest to senior citizens.
Click here
for all columns.
In addition to being a nationally
syndicated columnist and Certified Financial Planning Practitioner, Mr.
Voudrie provides personal, private money management services to select
private clients
nationwide.
Looking for an energetic expert who
is passionate about financial and wealth management? Mr. Voudrie is an
excellent speaker who will excite and inspire your audience. Mr. Voudrie
is available for a limited number of speaking engagements, television
appearances and radio talk shows. For bookings, email
jeff@guardingyourwealth.com.
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