THE one ride at the amusement park that I do not like is the roller coaster. I did not like it as a child and I still do not like roller coasters even after many attempts to enjoy it.
However, there are some interesting lessons to be learned from coasters for stock-market investors. Having been an observer rather than a roller-coaster participant, this is what I have discovered.
Watching the people line up to get on the ride might tell you if they have been on this particular roller coaster before. The veteran riders seem more relaxed while the “newbies” are usually either quiet or unusually animated. The previous riders know what to expect and the first-timers look like they are thinking hard about what to expect. After the ride is over, everyone looks like they are happy and smiling, but some are just happy the trip is finished.
The other thing I find interesting about riding the roller coaster is how quiet everyone is as the cars go up the ramp. After the passengers reach the top, then the shouting starts as they plummet down the track. Of course, the object of the experience is to “cheat” death as there probably haven’t been any cases of the ride eating its passengers on the trip up. It’s the trip down where the danger lies and where we find the excitement.
The stock market has its ups and downs also. From above 8,000 on the Philippine Stock Exchange Composite Index (PSEi), we traveled down the track to a recent low of 6,600 or over 18 percent. The biggest one-day fall on the New York Stock Exchange was the 7.9-percent decline on October 15, 2008, so 18 percent over five months is not like a roller coaster at all. But the months of August and September on the PSEi saw extreme volatility. From the July close to the August low, the PSEi went down over 12 percent. That is a big deal for our little stock market. Further, from the August low, three weeks later the market was up 9 percent. And, of course, there was that one week when the market went down 7 percent and then went up 7.5 percent all in the space of five trading days.
Last week the PSEi was up 2.5 percent and so far this week it has completely reversed again and is down about 2.5 percent.
As on the roller coaster, you can tell the ones that have taken this kind of stock-market ride before from the ones who have not. On the roller coaster the experienced riders are having a good time as they go up the ramp to the peak of the ride and are less inclined to scream and shout going down the ramp. Unlike the new ones, they know that they are not really cheating death. The experienced ones know exactly what to expect and are prepared for it.
Look at all the excitement as the PSEi was making its uptrend milestones with shouts accompanying every new historic high. That is particularly true with individual issues reaching new highs. The wise ones are happy to make a profit but are also very aware that, eventually, the peak will come and prices will go down. It is inevitable.
Stock price tops and bottoms are what every investor wants to catch. Conventional wisdom says that when a stock price reaches its historic high, there is no one holding the stock at a loss. Therefore, there is no overhang of potential selling to breakeven as when the price reverses to a downtrend. However, there is a massive overhang of holders that are ready to take their profit at any time. The only question is, when will that selling come in.
Does it make sense to buy the all-time high? Absolutely. Stock prices, and often stock indexes, tend to carry through with upside momentum at least for a short time. Determining a top is most easily done by watching the volume trend.
Price bottoms are different. At an historic low, for example, no one has a profit and as the price goes lower, more and more holders will sell. Price tops are hit more quickly; price bottoms can take a long time to form. Should you buy a potential bottom? Probably not. But here also, volume can give a big clue when the price has finally stopped going down.
You tend to think that it takes forever for stock prices to go up and that they come down very quickly. But in truth—as on a roller coaster—the trip up is slow but reaches the peak in a shorter amount of time than it takes for the ride down to the eventual bottom.
E-mail me at mangun@gmail.com. Visit my web site at www.mangunonmarkets.com. Follow me on Twitter
@mangunonmarkets. PSE stock-market information and technical analysis tools provided by the COL Financial Group Inc.