What Twitter's IPO Tells Us About Stocks

There are rules. And there are exceptions to rules. This is how lawyers are taught to think, and regardless of anyone's opinion of the legal profession, its analytical framework is second to none among professional disciplines. I bring this up now because it highlights the significance of nuance, and specifically how it relates to investing.

There's an enormous (and growing) body of research that proves just how bad most of us are when it comes to buying and selling individual stocks.

We allow fear of loss to impede the opportunity for gain. We selectively incorporate facts that support our opinions and ignore those that don't, even if the latter are patently critical to drawing a sound conclusion. And we take advice from people -- paging Jim Cramer -- that are, in fact, our financial adversaries or, at the very least, representatives thereof.

The net result is that the vast majority of investors end up buying high and selling low. And they do so again and again. We are, in this sense, nothing more than the oil that greases the palms of traders on Wall Street.

But of all the harmful things that investors believe, nothing is more pernicious than the confidence, which is present in so many of us whether we're willing to admit it or not, that we can time the market. That is, that we're sufficiently prescient to know when stocks are too high and when they're too low.

"Timing the market is a fool's game," says Nick Murray, the 2007 recipient of the Malcolm S. Forbes Public Awareness Award for Excellence in Advancing Financial Understanding, "but time in the market is your greatest natural advantage."

This is a point that my colleague Morgan Housel has made time and again. He made it most recently in an article about buying stocks right now despite the general feeling of euphoria. After noting that March 2000 was "one of the worst times in history to buy stocks" due to the Dot-com bubble, Morgan observed that "Someone who bought the S&P 500 (^GSPC 1.13%) in March 2000 and held through today has earned a 61% return on investment, including dividends."

It's here, in turn, where nuance comes into play.

There's no denying the fact that behavior has a negative impact on investor returns. And there's no denying the fact that much of that behavior is grounded in the naive belief that one can time the market. But, and this is the important point, it doesn't necessarily follow that we should be willfully blind to certain facts that indicate irrational euphoria.

As I've noted before, the greatest investor of all time, Warren Buffett, dissolved his first investment partnership at the height of the 1960s' go-go years, only to get back in after the market collapse of 1973-1974. And he's ridden similar waves on multiple occasions since then.

Not coincidentally, his mentor, Benjamin Graham, promotes investing with your eyes wide open as well.

Do they believe that you can time the market? No. But their actions certainly lead one to conclude that they do indeed try to avoid buying overvalued securities and delving into the market just when everybody else is.

So, what does this have to do with Twitter (TWTR), the popular social-media company that went public last week? It turns out, everything.

One of the surest signals of euphoria in the stock market is a period of overexuberant reactions to initial public offerings. And the response to Twitter was only the most recent example.

After its investment bankers twice boosted the offering price to institutional investors before Twitter's shares debuted on the New York Stock Exchange, the stock still proceeded to roar higher on the first day of trading, nearly doubling again.

And it's in good company. According to The Wall Street Journal, "six companies so far this year have doubled in price on their first day," the average "one-day pop" has for U.S.-listed IPOs has been 17%, and we're on track for the most IPOs this year in more than a decade.

What does this mean? If history is any guide, it means that investment bankers and those looking to offload their companies onto the public market think it's a good time to sell. And when they seek it's a good time to sell, you should think long and hard about whether it's also the best time to buy. As the old poker proverb goes, "If after 10 minutes at the poker table you do not know who the patsy is -- you are the patsy."

The point is that, yes, investors shouldn't try to time that market. But we would be foolish to ignore what's going on right now and thereby risk allowing ourselves to be caught up in the excitement that will eventually come crashing back down.