Adhering to your investing system is key to its success
By
Timothy Lutts, Chief Investment Strategist and Editor of
Cabot Stock of the Month Report
There are many successful systems for investing, from aggressive trading of
momentum stocks to long-term holding of
undervalued stocks. To be successful, all you need to do is identify your style and stick with it. The hard part, in our experience, is sticking with it.
Consider the risk-averse investor who resolves to buy only undervalued stocks. That’s a system that can work fine, provided the person has the patience to buy a diversified portfolio, and to hold each stock patiently until it reaches its full value. Trouble, however, can intrude in three ways. First, the investor may not buy enough stocks to achieve proper diversification. Second, he may not have the courage to hold a stock that falls 20% in the months after he buys it. And three, he may become so enamored of his profits in his winners (and transfer that affection to the stocks themselves) that he will find it difficult to sell those winners when they reach fair value, when he should be taking profits and redeploying the cash in other undervalued stocks.
The investor who resolves to take the aggressive route faces the mirrors of these pitfalls. He may buy too many stocks, forgetting that concentration pays in the aggressive growth arena, and that with too many stocks, he risks doing no better than the broad market. He may neglect to cut his losses short, rationalizing his inability to accept defeat by arguing that the market is wrong and his convictions will eventually be proven right. Many of those losses, then, will grow even larger, but he will hold stubbornly, waiting for the stocks to come back. Finally he may take quick profits in his winners too soon, forgetting that trends often go to extremes, and that the biggest profits come from the power of compound growth.
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