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Monday 23 October 2017

The traps in stock market

Trap is a device that is used for catching animal or humans and preventing their escape. Being in a trap is an unpleasant experience and is difficult and impossible to get out of it. I've been seeing the word "value trap" pretty often and I decided to read up more about it. To my surprise, there's more than one trap in the stock market!!



Let's start with the most commonly heard trap:

Value Trap:
Everyone love to buy things at a discount don't they? Doesn't it feels awesome to buy the all new iPhone X at $300 without any contract? This beautiful piece of iPhone X is trading way below it's book value! You realize that you're able to sell this iPhone to a second-hand dealer at $800! Now..you see the opportunity. For stocks, value opportunity is identified by certain metrics, such as low P/E of the sector, trading below book value and more. So once the value opportunity is here, bargain hunter will come cashing into the stock. However, when the value is never unlocked, the value investors is trapped in the situation.

Bear Trap:
Bear trap is a trap that incorrectly shows the signal of a stock that is in a rising trend to reversed and go down. Traders love this. They'll go shorting on stocks with expectations that the stock price to decline after they've discovered certain chart reversal pattern. However, in this bear trap, the stock price stays flat or might even recover. The shortist are now caught and trapped.

Bull Trap:
Now on the other hand, bull trap is a trap whereby it shows an incorrect signal of a stock that is declining, and is currently "bottoming out". However, the fact is, this stock will still continue to fall. Investors will then be catching a falling knife. Bullish investors that had purchased this stock will be trapped in this poor-performing stock and facing 2 choices - to cut his/her loss or average down. 

Superiority Trap:
Now this is strange. Superiority trap is a behavioral trap. This is also a very dangerous delusion. This happens when the investor feels that their investing skills are more superior than the others. I have no idea why anyone will feel this way but.. oh well. This is a some kind of cognitive bias. Confidence is a good weapon in investment however, over-confidence tends to kill. Investors with this cognitive bias will be trapped in a position that they believe will do well, but did not. As a result, they may end up losing a good sum of their monies here. 


2 comments:

  1. Nice sharing. Never knew there were so many traps!

    ReplyDelete
    Replies
    1. Hi KPO,

      Neither do I!! I just happen to be reading about traps and found out that there is more traps than I thought there is!!

      Delete