Why So Many Lose Back Profits

Whenever the stock market went on a continual up trend (especially lasting several months) and then followed by a major sell-down, a notable feature would be that many investors would lose back at least a portion if not all of their profits.
QUESTION: Why do so many of us REPEATEDLY lose back the gains we have made during the good time? Although many would simply attribute this to GREED, a study of the market behaviour and market participants’ behaviour revealed that there were deeper underlying causes for such a behaviour pattern. Among them were –

1. PRIDE: Many of us believed that we had the right winning strategy after we had made a series of successful trades. Pride then began to creep in and often led us to become over-confident, complacent, inflexible, stubborn or resistant to changes. Pride comes before a fall and humility before wisdom. The fact is that, in a rising bull market, just about everyone can make profitable trades easily and to behave like an expert, as little knowledge, skills or experience is necessary to be successful at this time. Our greatest enemy in the stock market is truly OURSELVES. We have complete freedom to decide what and when to buy or sell. Yet when things go wrong, why do many decide to blame, the big boys, analysts, falling US market, our remisers or friends or anyone else (except ourselves)? If we repeatedly achieved the same poor end-results, it should become obvious that we need to examine our operating method and ourselves.
2. FAILURE TO FACE REALITY & TO DICOVER A SUITABLE WINNING STRATEGY: It is a well-known fact that the majority of gamblers, traders, punters and speculators lose money. For many, stock trading is most exciting or thrilling so long as the trade is in their favour but it can also be very stressful and agonizing when the trade is against them. However, the reality is that not everyone has the right temperament, knowledge and skills to be a successful trader. How many of us are able to cut loss easily on a bad trade? Sadly, many of us buy a stock as a “speculator” but ended up as an “unwilling investor or baby-sitter”. Most people also tend to release (sell) too early all the “eagles that could soar to the sky” and to keep with them what are mostly “lame and sick ducks”. Hence, it is common to meet “investors” holding a long list of stocks that are mostly in losing positions. The market also has a clever but harsh way of dealing with long-time holders of losing positions. Occasionally, one of the lame ducks would miraculously recover and start to run far enough as to enable the owner to sell it with full recovery of capital loss plus some profits. This duck then would immediately transform itself into an eagle and soar to the sky bringing much grief and heartache to its former owner. It is for each individual to know his own strength & weaknesses & work out a suitable winning strategy for himself taking into account his risk appetite, resources & knowledge.
3. MARKET BEHAVIOUR & TIMING: In a major market correction or sell-down, many stocks often gave up several months of their price gains in just a matter of several days. Hence, the profits accumulated over several months of numerous trades were liable to be wipe out in just a few trades that suffered heavy losses. For those who decided to cut loss and concede “defeat”, their positions were rather similar to that of generals, like Napoleon, who had fought and won almost all their battles (except the last few ones) but lose the war. An important factor to understand was that the stock market generally moved ahead of fundamentals by several months. A bull market usually started in the face of bad news and bad fundamentals and ended when the economy usually remained strong and corporate earnings still rising. This accounted for the existence of bull and bear traps that many fell into. A Conjuror (Magician) is able to fool his audience because he is always “one step ahead” of them. Likewise, the stock market, always being “one step ahead”, has no difficulty fooling the “herd” through false rallies, breakouts and breakdowns. Investors who understand such behaviour pattern and who could keep themselves one step ahead of the herd, would likely have won at least half of the battles and the war because they would be buying and selling before the herd did. For one to do this, one may need to have a complete change of mindset.
4. THE BIGGER FOOL THEORY: When euphoria surfaced in a bullish market, many would be lured into chasing speculative stocks because of the presence of bigger fools willing to buy them at increasingly higher price. Speculative plays often ended abruptly; and when that happened their stock prices could see sharp falls rapidly bringing hefty losses to those who got caught.                                                                                                                                                                                                                        
5. Caught In Vicious Cycle: An investor who bought a stock at the high end of the bull market would invariably be holding it (regardless of whether it was a "defensive stock', “blue chip”, “corn chip” or “potato chip”) with higher downside risk and lower upside capital gain. When a bear market arrived (always unexpectedly), it would just be a question of time before he would be holding and sitting on a losing position (always  painful to cut loss & not many could take it). Unless he had averaged down his entry price, it would usually take a few years or the next bull market for him to recover from his losing position. By that time, the market would again be on the high end; and being so relieved and happy to be “set free from captivity”, he would most likely liquidate the stock with some profit but only to see it gone up much higher as was often the case. Being frustrated, he would likely buy into another stock, which would then also be at a high end; and hence, faced the high risk of being caught in another bear market downturn and becoming a “baby sitter” once again. This is one very bad move that all investors should strive to avoid.

Your posting makes sense, coming during a correction. But what if we are in the midst of a long bull run? People who took profit and exited the market would be the real losers, while those who appeared to be losing their papers gains currently would not know they are sitting on multi baggers until much later. Markets are very complex and ever changing - but I think the key to a good return is to understand the business and invest in those with strong fundamentals ....

Observer 2, Do keep up your good Posts. They serve as timely reminders and provide good insights as I try to formulate my investment and trading strategies. I have some questions. As market cycles usually takes 5-7 years to go round, isn't it too long a wait of five years, assuming we manage to get off at the market high, before we make our investments. During this 5 year hiatus, is Waiting all we can do if we do not want to take excessive risk ?

I supposed increasingly market cycles are shortening due to better communications like internet that brings the world together. Instead of the usual 5 to 7 years cycle, now any event(s) happening may just trigger a crisis causing the stock market to fall drastically.
1973 oil crisis
1983 recession
1987 black Monday
1991 Iraq kuwait war
1997 Asia financial crisis
1999 Dot com bust
2001 911
2003 SARS
2008 US financial crisis
2009 Dubai's debt
2010 Euro crisis / N. Korea
2011 Egypt unrest spreading to other middle east countries? unresolved Euro crisis? Commodities bubbles? High speed trading?
What is next? is everyone's guess.

You have both raised very valid questions, Yeh & Greenrookie. As there is no one good investment formula or strategy for achieving great results in the stock market and all investments have risks, managing risks well is crucial to attaining success in one’s investment. I do not have the best answer for dealing with a long bull run but I can share with you, very briefly, a workable strategy that can yield great returns with small calculated risks that is applicable to penny stock investment. This is -
“The Doubling Strategy”: The idea is to identify the best growth stock in a sector basing on whatever data or information available at the time. The stock must be considered as one having relatively low downside risk but rather high potential capital gain (capable of achieving at least a doubling in its share price) This would invariably be a stock with low PER and usually having little investor’s interest – easy to find at the early part of the bull market & impossible to find at the higher end stage. Such a stock is to be completely divested on attaining a certain target (eg. PE of 10x or 15x), or on first sign of it falling below expectation as a growth stock. The proceeds can then be utilized to buy another growth stock with much lower valuation and downside risks (repeating the whole process). Potential gains beyond a PE of 10x or 15x (depending on the type of stock and the stage of the market) are to be consciously left behind for someone with a bigger risk appetite to take over the stock. As for the boredom while waiting for one’s selected stock to reach its target, one could always build up a small position of the same stock or other stocks for trading purpose.
The remarks by Gin that “market cycles are shortening due to better communications like internet that brings the world together” is not quite correct as far as the Singapore market is concerned. Bull market cycles from 1970s to 1990s ranges from 2+ years to 4+ years; these were shorter than our recent bull cycle from 2002 to 2007. Crisis does not necessarily mean the start of a bear market. It could cause a market setback but the market could well stage a strong comeback if it has not finished its full bull run. A good example is the outbreak of European financial crisis around May 2010 causing the STI to hit a low point of around 2,650 in end-May. On 9 Nov 2010, the STI ended at a closing high of 3,313. There were also no lack of bad news and uncertainties (or “wall of worry”) accompanying the STI’s climb.

The Singapore stock market has undergone two major corrections after its recovery from its bear market bottom of 10th March 2009 with the STI closing at a low of 1,455 points. The first major correction occurred after the STI hit a high of 3,016 on 15 April 2010. The fall then was -365 points or 12.1%. The latest correction started after the STI recovered to a new high of 3,313 on 9 Nov 2010 and then fell to a low of 2,936 on 18 March 2011, for a drop of -377 points or 11.4%. Unless there are more bad news or crisis forthcoming to bring the STI to much lower level, investors, hopefully, could now look forward to see the STI recovering to test its last high of 3,313 level.
The latest major market correction would have wiped off a major portion if not all of the profits (if any) of all investors who rode through the correction. Such an event invariably caused many investors to attempt to seek pre-emptive measures to avoid a repeat of this kind of “losses”. Good traders would likely avoid holding stocks through a major correction but the vast majority of investors just do not have the temperament, knowledge and skills to become good traders. The best solution for most serious investors, especially long-term ones, would seem to be to ignore such corrections and ride through the correction period. A possible alternative may be for them to practice reducing a portion of their share holdings whenever they anticipate, or see a big correction coming. This, however, is easier said than done.
Anyone having a good solution to this problem would be most welcome to share it here.