This year's Nobel Prize in Economics was awarded to Dr. Richard Thaler for his work on behavioral economics. Thaler has done a great deal of work to understand the stock market.
Some economists start with the assumption that individuals make rational decisions when faced with economic choices, including how to invest in the stock market. Thaler took a different approach based on what he saw in the real world -- that people aren't always rational.
Thaler's research found that, when faced with the need to make a decision in the face of uncertainty, people resort to heuristics, or an approach to problem solving where an individual uses their knowledge from past experience to make a decision.
One way investors do this is by "anchoring" their perception of a stock. For some investors, they anchor on the 52-week low as a bargain price. If a stock rallies and then falls back to the 52-week low, these investors will be buyers. This explains why value investors often hunt for ideas on the list of stocks making new lows.
Another heuristic that investors apply is the tendency to rely on available information. They might look at a stock's price-to-earnings (P/E) ratio to determine whether the stock offers value. Sometimes, this happens in tandem with the "anchoring" concept I just mentioned, and you'll have investors anchoring on a P/E ratio they believe is low, such as 15, and deciding that a stock offers value when its P/E ratio is below that level.
"Anchoring" and "availability" explain why many investors believe the current stock market is overvalued. They have heard for years that the average P/E ratio for the stock market is around 15. With the current P/E ratio near 30, the stock market must be overvalued.
However, the market still offers value. For many investors, there is simply no alternative to the stock market right now. They understand that interest rates are low, with long-term rates near 2.3%.
Rather than accepting a guaranteed yield of 2.3%, which might not even beat inflation, investors look to the stock market. Buying may not seem rational, but given the choices and the recent data, the stock market may be the most rational choice for an investor.
Thaler understands that investors cannot have perfect knowledge and will sometimes act irrationally. They probably are irrational right now. In a recent interview, Thaler said, "We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping. I admit to not understanding it."
In An Uncertain Market, My Plan Stays The Same
As investors, we can't (and we won't) always be able to understand the market. But we can understand our own goals and priorities. In my case, the goal for my Income Trader subscribers and I is high income and my priority is safety.
We accomplish this by selling put options on quality stocks, using the option premiums we get from these trades as what I call "instant income."
For those who aren't familiar, essentially what we do is find a top-notch stock that we're willing to bet will not fall to a certain point. If we like what we see from our research, we'll make that bet on the options market by selling put options -- and pocketing a premium (the instant income) for our troubles.
At best, we can repeat these trades again and again, pocketing instant income (and potentially thousands of dollars) with each trade we make. At worst, the stock falls, but we end up owning shares of a quality company we already liked in the first place -- and at a discounted price.
That's why we like to call this the closest thing to a "win-win" in investing.
There's a little more to it than that, but not much. And in this market, where we're not sure of much -- it pays to stick to what works. For my Income Trader readers and I, that means sticking to my award-winning ITV Indicator. It's the same indicator that has helped us find winning options trades 93% of the time -- and earning thousands of dollars a month in extra income.
If you'd like to know more about how putting a new tool backed by a consistently winning strategy can work for you, then you can learn more here.
This article originally appeared on StreetAuthority.