The following email came in last week.
In the Cabot Wealth Advisory of 6/14/10 titled “Is Google Making You Stupid?,” Timothy cited a claim from Mr. Ranalli, founder of Helium website, “that the wisdom of the crowd trumps the wisdom of any one individual,” and agreed with that statement by adding, “it’s a message savvy investors know all too well.”
Now down further in the very same email where he hypes the Iconoclast Investor there is the statement, “Outstanding performance cannot come from someone who is always part of the herd.”
Has being an Internet user for the past 15 years made me stupid or do I see two diametrically opposed ideas endorsed not only by the same person, but in the same email? What does Timothy Lutts have to say about that?
Waiting with worm on tongue,
G.P.
I answered G.P., and I’ll elaborate on my answer here.
In the stock market, prices for each security are set by every individual and institution with a financial interest in that security. Thus, public opinion sets prices. As an individual, you may disagree with the market, but the fact remains that the market is never wrong. Thus the crowd that sets those prices is always right … from the current perspective.
On the other hand, market tops occur when the crowd is most bullish. That’s the point of maximum optimism, when people have the highest hopes for the future. However, when the last buyer has bought, and there is no fuel to drive prices higher, that’s when prices start to fall. So people who bought at the top quickly become wrong.
Similarly, markets bottom at the point of maximum pessimism. When the greatest number of people are selling in disgust and capitulation, a market bottom is created. And after the last seller has sold, that’s when prices begin to rise. So people who sold at the bottom quickly become wrong.
In sum, therefore, while it’s good to be part of the herd in the middle of a move, it’s best to lean the other way at periods of peak crowd perception/emotion. Of course, those points are only easy to see when reviewing the past.
And the worm on tongue? I had to go to Google to figure that one out.
Baited breath.