What this past week taught us about investing in stocks

What this past week taught us about investing in stocks

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The lesson: Stocks tend to discount a potential event going into the event and often reverse themselves after the event.

You don’t need to become Warren Buffett to generate good returns in the stock market. The magic of compounding is such that even a small increase in your yearly returns can make a huge difference in what you end up accumulating. So it’s a worthwhile effort to learn how to improve returns.

Over the years of helping investors through my newsletters and seminars at The Arora Report, I have found that investors are much more likely to learn from real-life events. There is an important lesson to learn from Hurricane Irma and Apple’sAAPL, +1.31% iPhone launch. Let’s first build the requisite background and then I will share with you a simple lesson that can significantly improve your returns.

Hurricane Irma

Ahead of Hurricane Irma, insurance stocks were being sold mercilessly. To help investors avoid making mistakes, I wrote “Hurricane Irma is distorting the price of stocks, including Universal Insurance.” I illustrated the point with the chart of Universal Insurance Holdings UVE, +0.48% which does a lot of business in Florida.

Please click here for the annotated chart of Universal Insurance Holdings. For the sake of full transparency, this is the same chart that was provided to investors well ahead of Hurricane Irma; no changes have been made to the chart.

I wrote in the article: “From a trading perspective, if the damage is significantly less than anticipated, the stock may not only recover the entire loss, but may go even higher to the zone shown on the chart. The reason is that after the hurricane, insurance companies may be able to raise rates. Furthermore, if the stock starts moving higher, a short squeeze may propel the stock artificially higher than the fundamentals may warrant.”

From the large number of emails I receive, social media and price action, investors were in a herd mentality. Not only were investors selling Universal Insurance, they were short-selling it and buying put options. Universal Insurance stock traded as low as $15.08. Since the hurricane, the stock has traded as high as $21.44. The Arora Report’s call has proven to be spot-on. Investors who heeded my call came out smelling like roses. Investors who followed the herd lost a lot of money.

A similar scenario happened to insurers such as XL Group XL, -0.56% Progressive Corp. PGR, +0.09% Travelers Cos. TRV, +0.10% Federated National FNHC, +1.23%Allstate Corp. ALL, +0.08% and insurance ETF KIE, -0.06% ; cruise lines such as Royal Caribbean Cruises RCL, -2.97% and Carnival Corp. CCL, -4.84% and airlines such as American Airlines AAL, -0.60% United Continental Holdings UAL, -2.80% and JetBlue Airways JBLU, -0.08%

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

Apple iPhone launch

I also wrote ahead of Apple’s iPhone launch this week: “Investors who recently bought Apple’s stock should consider locking in profits.” The herd bought aggressively going into the launch, running up the stock to $163.96. Mom and pop were especially actively buying the $165 weekly call options on Apple.

Please click here for an annotated chart of Apple. For the sake of transparency, this is the same chart, without any changes, published before the iPhone launch. I wrote: “For those who bought it (Apple stock) recently, it’s time to take partial profits.”

Since the launch of the new iPhone, as The Arora Report had correctly predicted, Apple stock has been drifting down. Apple stock has traded as low as $157.85.

The lesson

The lesson illustrated by those two events is to think twice before following the herd. Stocks tend to discount the potential event going into the event and often reverse themselves after the event. Investors who understand this end up making money. Investors who follow the herd often end up holding the bag.

[“Source-marketwatch”]