While most people are tearing their hair out over the recent market turmoil, for some it could be a blessing. “How?” you ask. Well, if you are decades away from retirement, especially if you've never invested before, now is a great time to start an investment portfolio.
The average investor tends to wait for a few good years of growth in the markets before feeling confident about putting money into stocks. Conversely, they want to get out of the markets when prices have dropped. This can be described as “buy high, sell low.” This happens to be the formula for losing money.
What we want is the opposite: buy low, sell high. It sounds like a simple concept, but in practice it is very hard to execute. When most media reports make it sound like the sky is falling, it's hard to get the courage to leap into the market.
Sometimes you will hear statements such as “there were more sellers than buyers on the market today,” or “sellers were in control of markets, sending the indexes down,” or other imprecise comments.
Let's take a look at the basic process of stock price movements. The current price of a stock is simply based on whatever the price was during the last transaction. If the price has gone up, it means that the most recent transaction occurred at a price higher than the previous transaction. If the price has gone down, it means that the most recent transaction occurred at a price lower than the previous transaction.
Further, that most recent transaction could have been for one share or 1 million shares – it doesn't matter, so long as there’s someone to buy what someone else is selling.
It's imperative to understand this concept: You cannot sell a share if someone else will not buy it. So when a market is falling, the number of sellers does not necessarily have to be greater than the number of buyers. Sure, it's possible that thousands of investors each sell a few shares, and only one investor is buying them all up at a lower price than yesterday. But it's also possible that there is only one investor with many shares selling them in small lots to many buyers.
The point I'm trying to make is that for prices to go down, someone has to be buying those shares. These are the investors who understand the concept of “buy low”.
The next time you hear a reporter saying “more buying than selling” or vice versa, laugh and tune out. The amount of buying and selling is always exactly the same.
If they say “sellers were in control of the market” when the market goes down, they are again mistaken. It's the buyers controlling the market in a decline. The market may be flooded with panicked investors looking to sell, but those shares only get unloaded when buyers step up to the plate.
So why do some investors step up during market sell-offs?
Past stock market behaviour doesn't tell us anything that helps us predict accurately what will happen in the future, but it’s worth pointing out some compelling statistics.
Tacita Capital Inc., an investment counselling firm in Toronto, notes that since 1950 there have been 37 declines of 10 per cent or more on U.S. stock markets. The average decline was 19.7 per cent, and in 34 of the 37 declines, the market was up by 26.8 per cent on average one year later.
For a well-diversified portfolio, there is a saying that “it's time in the market, not timing the market” that makes you money. But you can increase you likelihood of making better returns by doing both: investing for a long time and taking advantage of dips. If you are a younger investor, you've got the time. And with the recent market sell-offs now, you've got the dip, too.
This happens to be the formula for making money.
Preet Banerjee, B.Sc, FMA, DMS, FCSI is a W Network Money expert and blogs at wheredoesallmymoneygo.com . You can also follow him on twitter at @PreetBanerjee.