This is a tempting proposition that actually makes no sense. Is majority opinion usually wrong? Most people think that Man Utd will win the league this year. Does this mean that Man Utd will not win the league? The key is what odds are available for the chance that someone else wins? Are they attractive? It is quite possible that Man Utd’s odds are not short enough and they are a good bet, despite the fact that “everyone” thinks they will win the league. It is true that when probability is mispriced, taking advantage of it can make one feel like a contrarian and even something of a hero: but that’s just a side-effect of being a good investor.
“Never average down – don’t try to catch a falling knife – cut your losses, not your fingers”
This is really an adage suitable for traders who don’t want to get in trouble with their boss. For serious investors, a short-term share price movement is of little consequence. Clearly, we would like to know if there is an obvious explanation for the price decline. A key question is, is our asset falling in isolation or is it falling with the market? If the former, the vibes may indeed be bad. If the latter, there may be a liquidity squeeze meaning that others are forced sellers and the last thing you want to do is to join them.
If you are lucky enough to spot an undervalued and underappreciated share, the chances of you buying at the exact low point are tiny. Most if not all of my best ever equity investments have fallen after my first purchase. More often than not I have averaged down, successfully.
This phrase, frequently trotted out by so-called expert commentators and often preceded by a word such as “obviously,” is one that’s irritates me heartily. Markets price probability. Certainty, were it to exist, would presumably have no market price because there would be nothing to trade.
“It is cheap (or expensive) relative to its historical value”
This is another very tempting error and you see it trotted out constantly. It is the daily garbage thrown out by the stockbroking industry. Values are relative to the prices of alternative investments today; not to their own history; unless someone invents a time machine.
“You should pay up for scarcity”
Laws of supply and demand, right? In fact, this has less to do with economics than with sales patter. Scarcity = illiquidity, which may turn into a discount when you are the seller rather than the buyer.
“Index tracking funds are safer”
This is probably true to the extent that they are normally cheaper than hiring active fund managers whose performances are frequently disappointing. But why is guaranteeing that when the index falls, you lose money, safer? This is poor crowd behaviour – feeling better about losing money when everyone else loses as well. Index funds are good news when the index is rising: buying an index fund is not a solution in itself. It is what you can do after you have decided that shares are going up but you don’t have time to do the work of selecting them.