It was John Keynes, the influential British economist, who once said that “the market can stay irrational longer than you can stay solvent,” and it is an observation that is equally true today. So what does this sentence really mean?

Good in stock market terms basically refers to the fact that markets are not always rational and therefore there are times when the market undervalues ​​companies and overvalues ​​companies. It is for this reason that you can sometimes get bargains in the stock market and sell short companies that are clearly overvalued. You’ll often find that in bear markets almost all companies will see their share prices drop, even high-quality earnings-enhancing companies, creating good opportunities for some bargains.

However, what John Keynes said was that these irrational markets, which do not accurately reflect the true values ​​of companies, can remain irrational for long periods of time. While the stock will generally gain eventually, in the short term they could fall further in a bear market and vice versa in a bull market.

So if you’re looking for short-term profit by finding undervalued companies to invest in in a bear market, or overvalued candidates to short in a bull market, you may well lose money if markets continue to be irrational for the foreseeable future. .

In this day and age of many short-term trading methods, such as spread betting and options trading, this idea that markets can stay irrational longer than you can stay solvent is as true now as ever. especially if you are trading on margin. Therefore, if you are a short-term trader looking for contrarian trades in rising or falling markets, you should take steps to protect your capital. This means using tight stop losses and taking your profit while they are there or letting your winning trades fill.

If you are an investor this is not so much a problem. However, you still need to invest wisely. In this current climate there are plenty of bargains out there, but it’s important that you take a long-term view of the markets and invest only in quality companies that ideally pay dividends and are well positioned to grow earnings for years to come. You also don’t need to throw your money into the markets. A better approach is to trickle your money into these quality businesses when the opportunity presents itself.

The point though is that the market can stay irrational longer than you can stay solvent and you should always keep this in mind when investing in stocks, and certainly if you are trading short term using leverage.