How Can I Determine if a Potential
Investment is Overpriced?
Question: I’m not a savvy investor by any means. But I haven’t lost a fortune chasing hot stocks, real estate or other investments either. Over the past four years my investments (stocks, REITs and CDs) have broke even, over ten years I’m up about 9%. But I’d like to know if there’s a way to determine if a potential investment is overpriced.
E.C. Albany NY
Answer Marc Charles:
That’s a great question! I wish more entrepreneurs and investors would ask it. First….
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If your investments have “broke even” over the past 4 years, you’re probably in the top 5% of all investors; most people lost a bundle (but won’t admit it).
If your investments are up 9% over the last 10 years you’re also in the top tier. So, I disagree….I think you are a savvy investor.
I spent considerable time in the “trenches” as a commodity and currency trader. I made my living trading the markets. I learned many lessons over the years. But one lesson stands out from all others.
I call it the “Carpet Theory”.
The theory simply means “the carpet” for whatever financial asset you are trading can be pulled out from you at any time. There’s usually no warning whatsoever or logical reason for an asset to plunge or skyrocket in value. It is the nature of any market where people are involved. It’s like trying to figure out when and if someone will catch a cold.
For example, let’s say you had in-depth information regarding a particular stock. Let’s also say you knew about a company which was set to launch a new cell phone which would compete with Apple’s iPhone. Rumors started flying the phone would be an “Apple Killer”.
On top of that, let’s say you had in-depth information regarding the company’s financials (which were sound), management (they were all behaving themselves) and other factors. In addition, the large media networks like The Wall Street Journal were publishing stories about the greatness of the company. The hypothetical cell phone is released and the public goes crazy for it. People are thrilled with the first Apple Killer!
Plus, there are a ton of investors who would love to bring Steve Jobs (the Apple CEO) down a notch or two start buying the phone and the company’s stock! This frenzy continues for a couple of weeks.
And then, without notice, the stock plunges 70%, and fatal flaws are discovered in the phone (such as no texting). The company’s financial and management remain the same, and they have dozens of other successful products. But the “carpet” is pulled out from everyone who poured money into the company and their products…without warning.
When it comes to trading and investing you never know when the carpet is going to be pulled out from you. If you know this going into an investment, and plan for it, you’ll be fine. I always look at the downside risk before entering an investment or make a trade.
I understand the “carpet” can be pulled out of an investment at any time, without warning, for no logical reason. I’m especially concerned when the masses favor a particular investment or opportunity.
For example, Google and Apple are prime candidates for the “carpet theory”. The masses love Google and Apple products and stock. But the masses loved real estate and sub-prime real estate deals too.
Another aspect I keep in mind is cycles and waves. Hang on….I’m not going “technical” on you! It’s simple…..everything in life moves in cycles and waves.
Many so-called experts would disagree with me. But I think everything in life and business moves in cycles. The best part is most cycles are easily identifiable.
On top of that, the most dominant cycles often look like a triangle when you put prices on a chart, so they’re easy to spot. In other words, if you have the price history of an investment and put it on a graph it would look similar to a triangle.
I’m not talking about rocket science here. In other words, you won’t see a perfect equilateral triangle were all sides are equal. But the triangle will have a general form. The trick to applying this technique to investing is predicting when something has “peaked”.
One of the tools I’ve used is historical price charts… the longer term the better.
If you looked at commercial real estate prices on a historical chart it would look like a triangle, like this:
The same is true for the stock market, US Dollar, precious metals, collectibles, office real estate, fine art…and so on.
A chart of Google’s stock price over the past ten years or so looks like a triangle too. Does this mean the stock has peaked or could peak soon?
Granted, I realize this approach is pathetically simplistic, and it’s only my opinion.
You’ll need to approach the market and make investment decisions based on your own research. You should also consult a financial professional and only invest money you are willing to put at risk.
Here’s a ten year chart for Apple:
As you can see one triangle already developed, and now a second triangle is forming. Does this mean the stock is topping? I don’t know the answer to that question. But I would short Google and/or Apple stock…. or sell call options slightly higher than current prices.
As far as buying Google stock at $500 per share today and expecting it to go to $600, $700 or even $1000 per share in the next few months or years……I think this would be an unwise investment.
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Investment opportunities ebb and flow just like the ocean tides. You can always find opportunities if you’re patient. Two investment opportunities I like today are uranium and Japanese Nikkei.
Here’s a price chart of uranium:
Here’s a chart of the Japanese Nikkei:
If you apply the “carpet theory” to your investments, with a view toward cycles and historical prices (triangle) you should fare better than most.
I hope that helps. I’m always open to suggestions! So drop me a note!
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Your humble host,
(Ed Note: Marc Charles is referred to as “The King of Business Opportunities” ….and for good reason. He should be known as “The King of Legitimate Business Opportunities”…because he’s launched, bought, sold reviewed and advised on hundreds of businesses and money making opportunities. He understands legitimate opportunities. Marc has agreed supply League of Power members with crucial updates regarding legitimate business and money making opportunities.)