The majority of the general public seems to have accepted online stock chat rooms as somehow useful. Some of the over-hyped chat boards and news services include:
Let us be blunt. Imagine you receive a stock tip. You now know it is time to buy whatever the tip is. Big problem here now. When do you sell? How much do you buy? Of course, the tipsters never try to answer these questions. Stock tips are kissing cousins to the ever-popular lottery tickets. They might feel good, but stock tips are for losers (just like lottery tickets).
For example, the stock market crash painfully proved the worthlessness of stock tips. No tip predicted the NASDAQ crash. How in the world could an opinion of some anonymous message poster, that only knows how to yell BUY, ever be useful?
Trend following trading does not attempt to predict the market. We couldn’t care less what a company does or what its new economy potential might be. It does not matter what a company’s business plan is or even whether they have a potential to make money. When you trade properly, your only concern is price. If the price is going up you buy. If it’s going down you sell. Don’t waste your time trying to determine the potential of a company. And don’t waste your time looking for tips on chat boards. You will only lose money if you go down the stock tip path.
The Two Questions Tips Never Answer
The two questions the original text poses are the entire point. When do you sell? How much do you buy? These are not secondary considerations that can be figured out after you receive the tip. They are the two most important questions in any trading decision. The tip gives you a name and a direction. It gives you none of the framework required to actually trade it well.
When do you sell? Without a predefined exit, the answer is determined by emotion: when you feel good enough about the gain to take it, or when the loss becomes too painful to hold. Both of those timing signals are systematically wrong. Emotional exits cut winners short and hold losers too long. A complete trading approach defines the exit before the position is opened, based on price movement criteria rather than on how the current position feels.
How much do you buy? Without a position sizing framework based on account equity and current market volatility, the answer is determined by confidence in the tip, available cash, or round-number thinking. All three produce incorrect position sizes. Correct position sizing requires knowing the stop loss level and the maximum acceptable loss per trade as a percentage of equity. The tip provides neither of these inputs.
The lottery ticket comparison is precise. A lottery ticket feels like participating. It provides a story to tell: I have a ticket in the big game. A stock tip provides the same psychological function: I have a position in a stock I know about. Neither provides a rational expected value positive process. Both satisfy the emotional need to be in the action without requiring the work of building a system. Both transfer money from the participants to the other side of the transaction over a sufficient number of iterations.
The NASDAQ crash is the empirical proof. Every chat board was full of BUY opinions during the bubble. Not one predicted the crash. Not one had an exit mechanism. The investors who followed the tips experienced the full decline because the tip culture has no sell signal. Trend following had sell signals. When the NASDAQ broke below defined levels, systematic trend followers exited long positions and many entered short positions. They captured the decline that the tipsters’ portfolios experienced as catastrophic loss.
Frequently Asked Questions
Why are stock tips useless for building long-run wealth?
Because they answer the least important question, what to buy, and ignore the two questions that determine trading outcomes: when to sell and how much to buy. Without predefined exit criteria and correct position sizing, even a tip that correctly identifies a rising stock will produce inconsistent results because the execution of the trade, not the stock selection, determines whether you make money.
Why did the NASDAQ crash prove the worthlessness of stock tips?
Because no tip contained an exit signal. Chat boards were full of buy recommendations throughout the bubble and crash. The absence of sell criteria meant that investors held through the entire 78% decline because the tip culture only operates in one direction. Trend following systems had predefined exit signals that triggered during the initial decline. Investors who followed tips experienced the full catastrophic loss. Systematic traders following price exited or went short.
What is the difference between a stock tip and a complete trading approach?
A stock tip provides a stock name and a direction. A complete trading approach provides entry criteria, exit criteria, position sizing based on current volatility and account equity, and stop loss placement. The tip is one-quarter of one input. The complete approach is the entire framework required to trade correctly. Without the complete framework, even a correct directional tip can produce a losing trade through incorrect sizing, premature exit, or failure to exit a deteriorating position.
Trend Following Systems
Want to learn more and start trading trend following systems? Start here.
