- a friend tells you about a stock they bought and thinks its going to really move higher. You buy some before you even know what the company is all about
- You have bought or sold stock from looking at a chart thinking it “should do this or do that”
- You have bought or sold a stock from looking at a chart thinking “it can’t do that anymore(continue higher or lower) it has to do X”
- sold stock because it finally made it to break even and you just wanted to get out
- bought more of a stock for the sole reason that you would lower your average cost thinking that you are improving your odds of getting out without taking a loss.
- Check your stock prices every day (or more often) even though your investing and not trading
If you did any of these things in 2010 (if you have invested for years you almost for sure have done one or more of these “sins”) than you have made investment decisions based on emotion and not logic. As most seasoned investors know trading on emotion is the biggest killer to returns and capital there is. Day traders and swing traders make a living by feeding on peoples emotions and as someone who has day traded for years I can say that business is good.
How do you avoid the emotion trap that seems to be around every investment corner?
Firstly, you need to have written rules of when you invest into a company and when you will exit a company. These rules need to include everything. This is where most people fall far short of the bar needed to avoid getting into situations that they end up having to decide on the fly what to do. When I say everything I mean if the janitor decides to kill the CEO with the mop bucket that needs to be in the plan. Of course you can not have a list that is 600 miles long with every possible black swan that can happen but you can have rules such as “CEO and or senior executive(s) leaves without notice”. “company misses earnings but guidance is in line”, “positive news alert that moves the price up 10%”, “negative news that moves the price down 10%+” etc....
News sends a lot of emotion through the markets and it could be on a related company so you need to factor that in too. Especially news that is bearish for a competitor. Take MCP recently. News came out that they may not get one of the mines up and running as quickly as expected due to delays. This news sent a related company REE stock down. This was just crazy because if you think about it the news was actually bullish or possibly bullish for REE at least on its face level. Had the news been due to regulatory restrictions that are now being put in place MCP will be delayed that may be bearish for REE but it wasn’t but the market did not care and sold off REE for over an hour. Those that kept their emotion out of the trade and thought it though were able to avoid what appears to be an obvious land mine in hindsight. Those that found REE to meet the criteria to buy it from their written plan would have done very well without worry because they had written rules to know BEFORE something happens in which to exit with. The most important rule of investing is to have rules of investing and exiting. If you can’t take the time to put rules in place first then you will know for sure your more interested in the “action” than you are in making money. If action is what you want then you will get it but you will pay a very steep price for the thrill. A better place and maybe even a cheaper place to get the same thrill is Vegas where you will also be provided free food, hotel, drinks and more fun. Wall St. doesn’t comp customers or even say thank you when you spent your money.
The second most important rule is to follow your rules. Many people will have great rules and stop losses and when to add and to take some off the table but not follow the rules. Usually this is a case of “this time is special/different etc.....”. Guess what, no it is not. There is nothing new in the markets. its all one big repeating cycle after another with lots of noise and rumors and the symbols may change but the price action has not changed since it all started. The price is going to go up, down or just move sideways. So follow your rules that you made when you were rational and non attached to the current soon to be forgotten about stock and you fill find that over the long span of years you will come out so much further ahead.
The third rule of investing is don’t get to caught up listening to gurus. We all want someone to hold our hand and tell us its all going to be great or its time to get out while the getting out is good. The fact is that person really doesn’t exist. Not in the way that would help most investors. The market moves around to much and things change so that what was maybe great words of wisdom yesterday is garbage today or for sure worthless in a month. So forget the gurus telling you a stock is great or worthless (one well known guru said to stay away from V at the dead low about a week ago and also said to sell BP the day before the low was put in before moving higher). Solid non stop research on just a few names is what will get you ahead not hoping someone knows everything about every stock and can lead you the way to the pot of gold at the end. While your at it if your not day trading there really is no reason why time should be spent checking the latest price on each of your stocks when the time would be better spent researching other possible investments or the investments you already have.
1. Promise to take the time to write out your entry and exit rules and get it done before making any new investments or changes.
2. Follow your rules and when in doubt refer back to rule number one.(never make a rule while in a trade or trying to decide what to do)
3. Turn off the TV along with the emotion and do not get caught up in the mania but rather let the mania work for you.
Following these simple rules and most importantly avoiding some of the “sins” of 2010 will help you cheer in 2012 with finer bottles of champagne than you used for 2011.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in V over the next 72 hours.
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