Can you profit from Wall Street wisdom? To get an idea, let's analyze four of its standard adages, and I'll offer my thoughts on whether you should buy into them.
'Don't fight the Fed'
Is it possible to predict the direction of the stock market based on the actions of the Federal Reserve? The Fed has tools to stimulate a slowing economy and slow down an overheated one. It has employed various tools since the 2008 financial collapse to stimulate the economy, and many people are of the opinion that those actions resulted in the bull market. Now that the Fed is beginning to increase interest rates, will that mean a bear market for stocks? Should you sell?
The data is mixed on how stocks have performed during various periods of monetary policy by the Fed. My view is that if it were easy to predict the direction of the stock market simply by monitoring Fed policy, then I'd be rolling in money.
'The trend is your friend'
According to this adage, it's better to buy into a rising stock than a falling one, and better to buy in a bull market than a bear. The problem with this theory is that it presumes the trend will continue. Though there is some truth to this, it doesn't mean you are going to make money following the trend. Investing according to trends is also known as momentum investing. But much of the research on momentum investing says it's riskier than a more steady buy-and-hold strategy and that any higher return it generates is compensation for taking on more risk.
Needless to say, I am not in agreement with this saying. To illustrate, we need only go back to 2007, when stocks had surged for five straight years. The trend turned out to be anything but a friend the following year, when stocks plunged. With friends like that, who needs enemies?
'Buy on the rumor, sell on the news'
This adage is built on the belief that stock prices move in anticipation of events and reverse course when profit-taking occurs after the actual news is released. An example often used is that Apple stock soared shortly after it announced a stock split, only to begin falling days after the split. The same was true with Amazon's smartphone, which captured excitement but flamed out.
As intuitive as these examples are, it's important to remember that intuition typically proves to be wrong when it comes to investing. In the Apple and Amazon examples, both announcements were actually the news and not the rumor. In fact, both stocks increased dramatically over the year after the news was released. It may be true that you can profit from knowing something about a company that few others know, but trading after either bad or good news is announced is dicey.
'Stocks take the stairs up and the elevator down'
This adage holds that stocks climb in value slowly, yet fall precipitously. Examples include Black Monday in 1987, when the Dow Jones industrial average fell 22.6 percent in one day, and more recently in 2008, when stocks gave up the previous five years of gains.
But examples don't necessarily make truths, so I went looking for data by consulting Robert Waid, managing director of Wilshire Analytics. He looked at the average daily performance of the market and found that the big "down" days are, indeed, larger than the big "up" days. So that may help to explain why market plunges are so painful, emotionally as well as financially.
Though I think all of these adages are interesting, following them is more likely to take from your returns than to add to them. To some extent they involve market timing, and more trading is associated with lower returns. I'm using some hindsight here, but in March 2009, the elevator was in free fall, the trend was not a friend, the news was horrible and the Fed seemed inept. That's when the market hit bottom — and that was the time to buy stocks!
Allan Roth is the founder of Wealth Logic, an hourly based financial planning firm in Colorado Springs, Colo. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.
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