On Improving Your Moneymaking Habits: The Personal Side of the Investing Equation
By
Michael Cintolo, Vice President of Investments and Editor of
Cabot Market Letter and
Cabot Top Ten ReportFor Cabot Wealth Advisory 2/25/08
Sign up for free Cabot Wealth Advisory e-newsletterI really believe that one of the top things that separates Cabot from other publishers is our willingness to interact with subscribers. In good times and bad, day in and day out, we're answering questions from subscribers about stocks, the market, our judgment and our investment beliefs. Sometimes people think we're geniuses (we're not), and sometimes they think we're a bunch of knuckleheads (we're usually not), but overall, it's definitely a plus to get the pulse of what our subscriber base is thinking.
While the questions I've been asked generally range from "What do you think of XYZ stock?" to "Where do you think the market is heading?" one question that I'm almost never asked about is "What does it take to be a great investor?"
Said another way, everyone is focused on today's stock or tomorrow's headlines. I can literally count on one hand the number of calls or emails I've answered in nearly eight years that concern building a successful system that will generate above-average profits for years.
And the funny thing is, that system—while it involves many rules and tools for finding, buying and selling the best stocks at the right times—really begins with the individual. People are usually their own worst enemies when it comes to winning the investment battle.
All of this leads me to a last Sunday afternoon. With the market still in a downtrend, I'm re-reading a couple of good investment books to reinforce moneymaking habits, study up and re-establish positive traits.
I stumbled upon "New Market Wizards," the second in a three-book series by Jack Schwager, in which he interviews numerous top traders and investors, looking for insights. (All three books are highly recommended, and each is available cheaply in paperback.) This book, originally published in the early 1990s, contained an interview with William Eckhardt, who was actually a mathematician. Simply put, it's the best investing interview I've ever read.
In the interview, Mr. Eckhardt hit on many points that I want to summarize here. Sure, none of these ideas will tell you what stock to buy or sell this week, but the more they make you focus on the personal side of the investing equation, and the more you're in tune with your own tendencies, the more money you'll end up making.
Most of the following are interrelated with one another, but all are good to think about:
1. Too many people think about what the market is going to do. But the trick isn't forecasting what's going to happen; the trick is to think about many market possibilities...and have a plan of action in case it does happen. Specifically, you should focus on a few unpleasant possibilities (the market falls out of bed, or your stock gets hit on earnings), and decide ahead of time what you're going to do.
2. Investing is tough psychologically because you must train yourself to think exactly opposite of how you normally think. For instance, when you have a profit in a stock, the idea of a big pullback isn't comforting...but you must prepare yourself for that to happen. And when you're down on a stock, it makes you feel good to believe a rebound is coming—but usually it's best to cut the loss and admit you're wrong.
3. As I wrote above, you shouldn't put too much emphasis on the present. The reason investors want to take profits yet avoid cutting losses is because doing so makes them feel smart today; cashing in a winner obviously makes you feel good, and refusing to cut a loss means you still have hope that position will turn into a winner. But that tactic is the exact opposite of what successful growth-stock investors do.
4. The best investors usually go into the market with lots of fear—each loss hurts, so they do what they can to avoid them. A reckless, aggressive, cocky investor may hit a few homeruns, but it's only a matter of time before he gets on a losing streak and craps out. Said another way, the investors who prosper don't let a bad trade lead to another bad trade, which leads to another bad trade...and so on.
5. Realize this: Good investing systems go against normal tendencies. Studies show that people will choose a sure gain, rather than an investment lottery that has a higher expected outcome. And they'll shun a sure-but-small loss for an even worse lottery, as they want a chance of coming out ahead. Again, in the market, you should be doing the exact opposite.
6. Human nature does not operate to maximize profit—it pushes you to maximize the chance of having a profit (i.e., boosting your win rate). But, ironically, your win rate is not overly important; most great investors are successful on half of their trades or less. But the size of their winners dwarfs the size of their losers, which is how they make money.
7. In many ways, large profits are more dangerous to your future trading than large losses. Most losing streaks get started after investors have booked a big profit or two...leading them to lose their risk discipline and act more like gamblers than investors.
8. The market acts like an evil tutor that is trying to teach you to trade poorly. How? It spends most of its time in a trading range, which teaches you to buy weakness and sell strength. (Wrong.) Most small- and mid-sized profits tend to vanish, which teaches you to cash in your winners quickly. (Wrong.) It lulls you into looking for high success-rate techniques and systems, which, in the long run, are often failures or mediocre performers.
There were some other points, and other great interviews in the book. But it's good to spend a few minutes thinking about the above points during the current investing "offseason," reinforcing proper traits and realizing how easy it is to get pulled off track.
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