Investing in the stock market has gotten ridiculously easy. Maybe a bit too easy—video game-style stock-trading apps have proliferated, and some say they encourage inexperienced investors to get in over their heads with risky trading strategies.
On the whole, however, the democratization of stock investing is a good thing, and you stand a good chance of having a positive outcome if you follow a few time-tested rules: educate yourself on how the market works before laying down any cash; research the companies you plan to invest in; invest for the long haul; diversify your holdings; and understand the trade-off between risk and potential reward.
Tesla has been an excellent investment for many. Of course, it’s been a spectacularly bad investment for some, particularly short-sellers, who bet that a stock is going to decline in price.
Before investing in TSLA (or any stock), there are some things you need to know. First, TSLA is an extremely volatile stock—the price can go up or down by large amounts very quickly in response to news, or for no reason at all.
Second, TSLA is a story stock, meaning that its value is based on the fulfillment of a mission (in Tesla’s case, the quest to replace gas vehicles with electric ones), rather than on fundamentals such as assets and income. One of the most basic principles of investing is that stock prices are always based on future expectations, and this is emphatically the case for stocks like Tesla—a huge amount of future growth is “baked in” to the stock price.
Unlike more mundane companies, story stock firms are familiar to the general public, and are constantly discussed in the media—not just in publications that cover the stock market or the company’s industry. Tesla has taken this phenomenon into Ludicrous mode—the mere mention of the company’s name is a sure-fire way to generate online traffic, and hundreds of articles, videos and comments about it appear every day, many of them written by people who have no idea what they’re talking about, or who have agendas of their own.
Above: A discussion about how TSLA remains an attractive pick for both traders and long term shareholders (YouTube: TD Ameritrade Network)
A third important fact about Tesla—one that infuriates many traditional stock-market pundits—is that its stock price doesn’t always follow the usual rules. Its shares behave more like those of a startup tech firm than like those of an automaker, and sometimes move in inexplicable ways. For example, when a company announces earnings, its stock price goes up if the numbers exceed pundits’ predictions (a beat), and goes down if the figures fall short of expectations (a miss). Things don’t always work out that way at Tesla earnings time.
There’s a divide in the stock world between long-term investors and traders. The former buy a stock and hold onto it for as long as the company’s prospects remain promising, typically for years or even decades. The latter buy and sell frequently, trying to capture short-term gains. Volatile stocks like Tesla are quite attractive to traders—it’s not unusual for it to rise or fall by a double-digit percentage in a single day, so a well-timed trade can deliver a gain in one day that most would consider a respectable return for a whole year. (Of course, that gain can easily be wiped out the next day.)
Contrary to popular belief, short-term trading is not necessarily much riskier than a long-term buy-and-hold strategy. Certainly, there are some complex trading techniques involving options that are inherently very risky. And trading without knowing what you’re doing is always foolhardy. But if you have patience and a strong stomach, the risks can be manageable.
It may sound counterintuitive, but getting good at short-term trading is not a short-term project. The key is to follow a particular stock over a long period of time, so that you become familiar with how it typically reacts to events, and can make educated guesses about which moves are likely to be brief blips, and which may signal new trends. Above all, follow the golden rule: never buy a stock that you wouldn’t want to hold onto for the long term, because if the price unexpectedly dips, that’s just what you may have to do in order to end up in the black.
The real drawback to trading is that short-term traders always miss the big upside moves, and Tesla is the perfect illustration of this. If you had bought TSLA in late 2020, when it was trading around 400, with a target of earning a quick 10% gain, you might have done so easily (and repeatedly, if you were lucky), and given yourself a hearty pat on the back. But a couple of months later, you would have given yourself a sharp kick in the ass as you watched the stock soar to over 800, and your more conservative buy-and-hold buddies started offering you glasses of Champagne.
Conventional wisdom is that trading on news is a sucker’s game. This is because, for every individual stock, there’s a group of institutional investors, sometimes referred to as the smart money, who follow the company closely. These pros may not be privy to confidential company information that insiders such as company execs have (insider trading is technically illegal), but they do have access to news sources that ordinary investors do not.
When a market-moving news item is announced, the smart money will know about it within seconds, and place their bets accordingly. By the time the news hits the Times and the Post, the stock will have already made whatever move it’s going to make. Retail investors who buy or sell when they see the news in mainstream media are likely to do so at precisely the wrong time, just before the stock bounces back in the other direction.
However, with story stocks like Tesla, a different dynamic sometimes applies, because there are so many casual watchers (sorry, but they’re referred to as the dumb money) who will trade when they see a headline on their Facebook or Yahoo feeds, hours after the news originally broke. Money of average intelligence can, if it is fleet, get in between the smart and the dumb and make a quick profit.
Just remember rule #3 above—TSLA does not always do what stock-watchers, smart or dumb, expect it to do. Also worth mentioning here is that, once a stock-price pattern of any kind is identified and discussed, it often ceases to be a pattern. You have been warned.
Written by: Charles Morris