A Skeptic's Guide to the Stock Market
Updated: Jan 30, 2019
Many doctors, especially those new to investing, view the stock market with distrust or downright fear. As well they might: the players are hypercompetitive, outcomes are unpredictable and rules are gamed almost as fast as they are written. If you like systems that can be mastered with hard work and careful application of principles, stick to the ICU.
Unfortunately, you probably need to invest in stocks if you want to beat inflation.
I am not an investing professional, but I have learned enough that the stock market is less mystifying to me than it was. You can do this, too. When you do, you will see that most of the daily news from the market is just static and most of the pundits don’t know any more than you do. The really scary investments will become more obvious. You will, hopefully, be less likely to get caught up in the drama with your own money.
So here is my take on different approaches to investing in stocks. There are many more out there, and many investors who will no doubt disagree.
Speculation (also called day trading, momentum investing, technical investing): Speculators buy stock when they think the price is going to go up, and sell when they think it is going to go down. This is also called the “greater fool” approach: buy a stock and hope that some greater fool comes along to buy it from you for more than you paid for it. The underlying qualities of the company don’t matter; all that matters is what is going to happen to the price next, often in the next hours or days.
Many people have developed many different ways to forecast how individual stocks are going to move. These are called technical indicators. None of them work consistently, because this is not a science. Stock prices move for many reasons, including the emotions of buyers and sellers.
Value Investing (also called fundamental analysis): Value investors analyze the underlying strength of the company, and try to buy when they believe the stock is priced below its true value. Most value investors believe in buy-and-hold, although how long to hold is open for debate.
Value investing appeals to many people because it seems rational. The problem is, you can’t know for sure which companies have strong fundamentals and what price constitutes a sale. The number of ways that companies can report their financials is astonishing. If value investing was easy, we would all be Warren Buffett, and even he has made mistakes.
Speaking of Warren Buffett, he has famously said that anyone who is not willing or able to undertake fundamental analysis should just invest in index funds.
Index funds buy shares in proportion to the market as a whole. You own a little of everything and your account rises and falls with the market. Index fund investing is, essentially, betting on the American economy. If you want to learn more about index investing – and a comprehensive take on personal finance – check out the Bogleheads.
As has been said about democracy and government, index funds are “the worst way to invest, except for all the others”. When the market goes down – as it does on a regular basis – it is really painful to watch your account balance go down too. There are lots of tools to help you resist the impulse to dump all your shares when this happens - roboadvisors, financial planners, automated investing via target date funds - if you think you are likely to react emotionally to market highs and lows. If you have been through a bear market before and kept your cool, all you may need is a solid asset allocation and your own steely resolve. You got this.