How not to be the first to sell and last to buy

Human beings are funny creatures. If there’s a new type of funky shoes in the market and nobody wears them, you probably won’t either. But if enough people wear them so that they attain ‘cool’ status, then their popularity will explode. This phenomenon follows the theory set out by Malcolm Gladwell in his book The Tipping Point.

Similarly for a book, if it makes it to the bestsellers list, more people will be enticed into reading it and that in turn will boost sales. So apparently one trick employed by publishers is to buy the books they want to promote from the retail outlets themselves. They have a rough idea of how many books they need to buy in order for the book to make it to the list of the week’s top 10. Once on the list, sales will have their own momentum.

The same mechanics work for stocks and shares, as well as the property market. Some people know that certain stocks are trading below their intrinsic value. But they are unwilling to put money there, until and unless they see that the share price is stirring.

The thinking, of course, is they want their money to get to work almost immediately. This is the trader mentality.

And once a stock starts moving, many more buyers will jump in. And if there is more demand than there is supply, the price will be pushed up even further.

It’s the same story in the property market. Up till two years ago, many people had reservations about committing to a property investment. Now that prices have moved up sharply, and at an accelerating pace, more people are coming into the market to buy.

Now let’s examine the effect of price changes on people’s decisions.

Price changes will attract more supply or demand. On the supply side, it is easily understandable. When a producer sees that he can get more money by selling more products, the logical decision might be to produce more. But that decision cannot be carried to its logical conclusion, which is to keep increasing production capacity. At some point, demand will taper off, and if the producer is not careful, he will be stuck with a lot of excess capacity.

Different tactic

But some suppliers might employ a different tactic. When they see prices moving up fast, and if they cannot increase their supply, they may well hoard their products. In other words, they will hold back their supply to the market, in the hope of subsequently getting a much higher price.

On the demand side, the effect of price change is more intriguing. According to economics theory, for elastic demand, the higher the price, the lower the demand. This would apply to discretionary spending and goods with close substitutes.

So if prices get too high, and assuming income does not increase as fast, people will have to cut down on consumption or shift to cheaper goods with similar functions.

A change in price has less of an impact on the demand for necessities. For example, if someone is sick and needs a doctor and medicine, that person will have to pay whatever is asked.

Then there’s another type of product, where the higher the price, the bigger the demand. Perhaps two types of products would exhibit this kind of characteristics. The first are luxury goods, or goods that signal to the world one’s elevated wealth or taste status. Another would be products whose value is difficult to ascertain. This would include stocks and shares. In this group of products, the element of fear and greed will come into play.

One of the oldest tricks in the con-man’s bag is this: Approach a stranger and offer to sell something totally worthless, like a bag of stones or obsolete semiconductor chips. Quote a price, say, $100, and the stranger will say: ‘You are mad.’

Then the con-man’s accomplice will act as a passer-by who has overheard the conversation. The accomplice will say: ‘Wow, you mean there are still these products around? I thought there is a shortage now. I know this person who’s willing to buy this at $150 per bag. OK, I will pay you $100 for this bag.’

After the first con-man has left, the accomplice will say to the victim: ‘Oh, I just remembered that I have to bring my mum to see the doctor. I’m supposed to meet this buyer in half hour. Do you want to make some quick money? I’ll sell these two bags to you for $120 and you sell to him at $150.’

Some people actually fall for the trick. In this instance, the promise of being able to sell at a higher price is the motivation for the purchase. Of course, there is no guarantee that the promise will be fulfilled.

Jack Treynor, author of the article ‘What does it take to win the trading game?’ identified three key trading motives: value, news/information, and cash flow.

Value buyers act when they see things they consider cheap, and are willing to wait for the market to recognise the value. They can take their time to accumulate a stock, and hence reduce the cost of trading.

Information traders, meanwhile, act on new information and changing expectations of the market. So if one has new information not widely known in the market, one can reap the benefits.

Therefore information traders are always under pressure to complete trades before the information spreads across the market. They are time-sensitive: their goal is to get the trades done quickly, even if this means paying up for liquidity.

As for traders with cash flow motivations, buying or selling is dependent on their desire to increase or decrease equity exposure, independent or even ignorant of the prospects for the stocks. Those getting into the market believing they can make a quick profit belong to this group.

Ultimately, a successful investor and trader is someone who can adapt quickly to a changing market.

A value investor may have identified a stock early and have held on for two to three years before the market starts to recognise it. And when the market starts to bid up the share price, the value investor may be tempted to sell once his target price is met. However, if he noticed continued strong buying interest - as every completed trade provides feedback to the trader - then he may want to hold out a bit longer.

Objective

In the final analysis, the objective of any investor or trader is: To avoid being the first to sell and the last to buy.

Everyone wants to be the last person to trade with a big contraparty - not the first.

This is evident in the numerous property en-bloc sales taking place now. When the wave was just taking off, many owners who missed their last opportunity to sell their properties in the last bull run grabbed the first offer that came along. And the offer was generally not great, on hindsight. But after the developer has accumulated a big enough plot of land, the last project to hold out - generally the smallest piece of land - will be paid the most.

But of course holding out for more entails the risk of missing the last buy order.

But what’s true is: being savvy in reading the market, and timing and implementing one’s sales and purchases, is as important as picking a good investment in maximising one’s overall returns.

Source: The Business Times, 28 April 2007