Stop Using Only Stops
I've titled my Cabot Wealth Advisory "3 Ways to Become a Better Investor," but don't worry--I'm going to steer clear of the usual advice that you get all over the Internet. ("Ignore the market's fluctuations! Be a long-term investor!" Yadda Yadda.) I'm also going to avoid talking about vital-but-basic principles, such as cutting losses short and letting winners run.
Instead, today's discussion stems from three points that have coalesced in my mind during the past few weeks, mainly in response to subscriber questions. I can't say that I've never touched on these points before, but each is valuable, and should help you improve your results both during this downturn and, especially, when the bulls re-take control.
Track Your Results
I'll start with a piece of advice that few advisors ever write about, but I've found it to be a key difference between winning and losing investors. It's so simple that it seems unnecessary to advise people to do it--you'd figure most would already, but I've found just the opposite.
The advice: Track your results. Simple, right? Yet I've found that most individual investors really don't track their portfolio's results to any great degree. Sure, they might look at their monthly statements and smile when they've earned a few thousand bucks, but they don't systematically follow and track how they're doing.
For example, if I asked you what your return is so far this year, do you know? What about during the past two years? How have you performed versus the market (though comparing yourself too closely to a benchmark can be counterproductive) during those periods? What does your equity curve look like (a graph of your results month by month)?
I know a lot of that stuff seems rather involved, and it does take a couple of hours to load data into a spreadsheet. But after that, it just takes a few minutes each month (or, if you want, each week) to update the data and any graphs you have.
Consistently following your portfolio's value and returns is a MUST if you want to be a serious investor. If you're not really following how you're doing, then investing is more of a hobby for you. And you know what hobbies do, right? They cost you money!
In all seriousness, the main reason to track your results is to keep you from getting too far off track--you'll know, for instance, if you're down 10% over the past two months, which you may think is just too much of a drawdown. Or maybe you just notice your swings in general, both up or down, are too big (or maybe too small, if you're only buying very small positions relative to your overall portfolio) for comfort. The point is that you'll be able to have some actual data on how you're performing.
Beyond just total returns, you can delve deeper into the data. You can calculate a rolling three- or six-month return to reveal your worst and best stretches. You can calculate how many months are positive vs. how many are negative (batting average). And you can calculate how much you make in your average positive month, versus how much you lose in your average down month (slugging percentage). And this says nothing about the data from individual stock trades!
Granted, those last calculations will take a bunch of time and effort, but the point is that the more you pay attention to and study your own results, the better investor you'll be.
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Next on the list is somewhat related to the first. And it's something that I have written about in the past, but believe is worth talking about again.
It's about knowing yourself ... as in knowing what kind of investment style fits your personality. Some of this is very broad-based stuff, such as whether you're more suited to growth investing or value investing. But it goes far beyond that.
In my years of investing, I've tried lots of different styles--everything from investing conservatively and taking quicker profits, to buying big positions and averaging up as the stock advances. After much experience, I've found that I freak out when my portfolio's swings get too big. I prefer a steadier equity curve (relatively consistent gains, but fewer months when you really hit it out of the park). But that's just me.
Other investors that I've known are the exact opposite--they shoot for the moon, and tend to have lumpy results. But when they catch that big winner, their portfolios soar!
But the bottom line is that I have defined, for the most part, what kind of investing fits my own personality. Of course, I'm always tweaking things and trying to improve. But I'm not trying to be something that I am not. And that is the real key.
I think many investors earn sub-par returns because their buying and selling rules and tools (if they have any) aren't really compatible with their personality. And that means that when the going gets rough, they lose their discipline and make all the wrong decisions ... and lose a ton of money.
So give some thought to just what kind of investment style really fits your personality--it's sure to result in bigger profits and, just as important, more peace of mind.
Stop Using Only Stops
The last way to improve your trading has nothing to do with the first two points. It has to do with selling stocks. Specifically, with using stops, or stop-loss orders, which tells your brokerage firm to automatically sell your stock if it falls below a certain price.
Let me say first that, for the average investor, I like stop-loss orders. It allows you to have protection on the downside, and being able to define your risk is very valuable in the market. Actually, I would go so far as to say that everyone should have some sort of stop on every stock they own.
However--and this is the main point--my impression is that the majority of people I talk to use stops as their sole selling tool. Mistake! It's like having only a hammer and some nails in your tool belt. Is a hammer useful? Very. But you'll be a better handyman if you also have a wrench and pliers.
Stops are solely a DEFENSIVE selling tool, i.e., you'll always be selling on the way down. In other words, every sale will be 8%, 10%, 15% or sometimes even more off its recent peak. That's not a terrible thing, but if that's your only selling tactic, you're likely to have a bunch of frustrating periods, such as when you buy correctly and ride a stock to a 25% gain ... only to sell it a few weeks later for a profit of just 10%.
Thus, if you're one of these investors, I advise you to develop some OFFENSIVE selling rules (selling on the way up). It's hard to do, I know--when your stock is rising and you're up 20% or 30%, it's hard to say to yourself, "Things are good now ... but maybe a little too good, so I'll sell some shares." But balancing offensive selling with defensive selling will almost always produce superior results.
What are some offensive selling rules and tools? One might be if a stock has been advancing for a while, and then gaps up on some non-earnings related good news (analyst upgrade), you could book some profit. Or, you might develop a more rigid set of guidelines-maybe if you get a profit of 10% or 15%, you sell one-third of your shares right then and there, but then trail a stop for the other two-thirds.
Now, I am not trying to sell you (no pun intended) on a specific offensive selling system. There is no one perfect way to do things! My point is that if you're only using stopsas a way to sell stocks, take some time to develop one or two ways to sell at least some shares in some of your stocks on the way up. It will likely boost your results and lessen the swings you see in your portfolio ... and these are both good things.
That's all the time I have for now. Until next time,
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