Why we never learn (reinforcement and punishment)
When we buy stock, we hope that the price will go up, so we will make a handsome capital gain in addition to the stream of dividends that the company pays us. There are two principal ways in which investors go about this, the high-risk method and the low-risk method.
The high-risk ploy is to buy high and sell higher, which will work for a while in market bubble conditions. However, this is really the market equivalent of playing musical chairs. Sooner or later the music will stop and most stockholders will be left holding a near-worthless parcel of stock. This is also commonly known as the ‘greater fool method’, because it depends for its success on fools finding greater fools to buy their stock at ever higher prices.
The low-risk approach is to buy when a stock is cheap and sell when the stock becomes expensive. It does not really matter which stock we invest in. Unless we buy when prices are low and sell when prices are high, it will be difficult to make profits consistently. This is what the great value investors like Warren Buffett and John Templeton have done over their long careers.
Yet, when we started out learning the craft of investing, most of us will have failed to do this. Instead, we will have done something that is seemingly inexplicable to independent observers: we will have consistently bought at high ...