Debunking share trading myths

Myth 1 – what goes up must come down

A share entitles the owner to a fraction of the net profit of a company – the net profit being what is left over once the company has paid employees, suppliers, energy costs, debts and all other stakeholders. This makes the return for shareholders more volatile than the return for employees, bond holders and suppliers.

As the shareholder is last in line to be paid, and although the returns will be volatile, the shareholder expects them to be positive and permanent over the long run, and higher than the return on bonds, treasury bills, and other ‘safer’ investments. Despite share prices having their ups and downs, they have trended steadily higher over the years and, and at a faster pace than vehicles like bonds and Treasury bills.

This steady upward progression shows that the laws of physics do not apply to share trading. As they continue trending upward, at some point they will advance so far that they will never reach their previous levels.

In January 2003, Commonwealth Bank shares fell below $25, following their 2002 high of nearly $35. Over the next five years they trended up above $60 per share, before falling to the previous low of $25 in the 2008-2009 Global Financial Crisis. Since January 2009, the share price has had a much steeper climb, reaching $55 in just over a year – this fast rise indicates that the investors got a bit skittish in the crisis, but that the value of the company held. Between January 2010 and July 2011 (the time of writing) CBA shares have steadily traded between $45 and $55.

When CBA was first publicly listed in 1991, shares were $5 each. The share price will never reach $5 again, and it is unlikely to fall back below the $25 point. As it continues to trend, the share price will one day never fall below $45, and then never fall below $55.

Share price trends consist of a series of ups and downs, but typically result in a net increase over time.

Myth 2 – what goes down must come back up

For new traders who know that shares usually trend upward over time, there is a prevailing belief that whatever goes down must come back up. This leads new traders to buy a share that has fallen from $30 to $10, believing that it is more likely to return to $30 than a stock that has risen from $10 to $15.

The opposite is true – over time, shares develop trends. They can be downward trends as well as upward trends. If a share is going to rise from $10 to $30, it needs to pass through $15, $20 and $25. It does not need to pass through $8, $7 or $6.

To get an idea of the wider trend in a market, it can be useful to study historical chart patterns – if investors had looked at the CBA charts in 2008, they would have realised that after the initial panic sell-off of shares in the financial crisis, the share price would return to its former upward trend.

When examining charts, find shares that have made positive moves of 300%-1,000%. Although share prices will inevitable have drops, most of the time these drops don’t exceed 30% of the share’s peak price (this excludes exceptional circumstances, like the financial crisis, which are usually temporary).

Myth 3 – you need to predict the share market’s movements to profit

Many assume that shares bounce within the same range forever, meaning that, to make a profit, traders must be able to predict the share market’s movements. This has resulted in brokers selling their abilities to predict share market movements to clients, along with successful traders writing best sellers.

Although this can be the case in short-term trading, the share market trends upward over the long term – even when it fluctuates between support and resistance levels, these levels are often also trending upwards. Consequently, investors with a buy-and-hold strategy can make a profit without being able to predict intermittent price movements.

Myth 4 – you need a degree to trade shares

Anyone can trade shares anywhere, at any time. That being said, you can’t be a successful trader if you go in blind.

It is crucial that traders educate themselves about the share market, especially the companies in which they own shares. The investors that do their research are the ones that succeed – this includes keeping up-to-date with company announcements and economic news, as well as studying chart patterns.