Even though most people lose money trying to trade individual stocks, they will continue to invest and trade because
a) It’s very easy to. You cannot drive unless you pass the DMV requirements but you need nothing but $1000 to open a brokerage experience and start putting your net worth at risk!
b) People are people – emotional beings and the markets are most of all, a manifestation of these collective emotions.
Here are some of my random thoughts about investing and trading.
- 80% of mutual funds cannot beat the S&P-500 index. (In my opinion, it’s because S&P is continually balanced- when they swap out poor performing companies with new star performers!)
- Stock markets have a tendency to go up over a very long period of time. But the same is not true for ‘shorter’ periods of time. 2 extreme examples below
1975-1999 (25 years )
21 up and 4 down years and the worst decline was 11%
- S&P went from 70 to 1468. It became 20 times in 20 years
- 18% CAGR (Compound Average Growth Rate)
2000-2012 (13 years)
- NO growth. same level
- Worst decline was 38%
NO ONE knows the future but it may be a easier endeavor to dollar cost average one’s way into the future.
- People don’t know the `secret’ of investing success – it is compound interest.
A small steady return over a long period of time is better than a volatile return. Here are some places to plug numbers and play.
Kinda like habits… Slow and steady goes a long way!
- The best way to think of investment is the return you are getting ABOVE the risk free rate of return (which is currently effective 0%!)
Imagine, in the 1st scenario above when the market was going up 18% on average per year, and bank interest rates were high, someone had a 20% annual return. Seems awesome, doesn’t it.
2nd scenario, market flat, rates close to zero. someone making 2% CAGR seems peanuts
It’s effectively similar!
- In trading, it’s not how much money you make in a bull market, but how much money you do NOT lose in a bear market. I strongly recommend reading Market Wizard series – it’s about trading and investing using numerous techniques but all these super stars had ONE thing in common – they managed their risk very well! Meaning, they did not lose big sums of money!
It’s the tyranny of Math,
- Lose 30% – have to make 42.85%
- Lose 50%- have to make 100%
- Lose 70% – have to make 233%
- Lose 90% – have to make 900%
Just to BREAK EVEN and get back to where you started !
- When I started, I was in equities, options, futures – but someone told me you have to be average to trade equities, smarter to trade options and smartest to trade futures. Because loss is amplified when you trade options and you can actually lose more than you have in futures! So, I stuck primarily with equities
- Trading is most of all a game of psychology. And why shouldn’t it be – People Buy and people sell!
A well-known trader published ALL his rules, knowing that no one can follow them. One has to be disciplined and do things that seem counter intuitive. (But once you draw parallels from life, it’s not hard to understand)
- Wall Street will NEVER tell you to sell – the analysts will always say it’s a buying opportunity because they want you to stay invested and give them commissions. If you sell, they get nothing.
- It is one of the hardest professions of all, because ONE mistake can ruin it all and put one of business. LTCM (Long term Capital Management) had numerous Nobel Prize winners as partners and they almost sank the worldwide currency markets.
In other professions, let’s say after 15 years, if you make a mistake, at most you get fired but you keep your prior earnings. In investing, that can mean ruin.
The best analogy is mountain climbing – One mistake and you are done!
- In my experience, the ONLY way to succeed is to disassociate yourself with individual stocks and meticulously track the total account. Most people fall in love with the positions they own.
- If you are an individual, according to Warren Buffet, dollar cost averaging may be a potential way to go.
“If you like spending 6-8 hours per week working on investments, do it. If you don’t, then dollar-cost average into index funds. This accomplishes diversification across assets and time, two very important things.
Just pick a broad index like the S&P 500. Don’t put your money in all at once; do it over a period of time. If you’re not professional, you are thus an amateur. Forget it and go back to work.”
Market Thoughts (Nov 2010)
We would rather be ruined than changed;
We would rather die in our dread
Than climb the cross of the moment
And let our illusions die.
I usually share thoughts on market timing and stocks, when I see them close to making an imminent move. It’s a function of the time when I started to trade on my own, back in the mid 1990’s. I developed a trading style with an eye for stocks that I feel are ready for a move soon, so that I can deploy capital into stocks that are active and then focus on something else that is ready to move.
But once in a while, I like to share thoughts that have nothing to do with the market or stock direction guidelines but those that form the very basis of our trading mindsets. Please see note on Oct 13th for more such offbeat thoughts
Many remain confounded between the disconnect between bleak fundamentals and firm technicals. The fundamental situation can seem robust but there can be technical and sentiment anomalies And the other way around.
I like to step away from all this and like to find answers from our real lives. As humans, we are very focused on our immediate gratification. [Ask anyone who suffers a hangover every weekend :-)]. Long term consequences do not often deter people from making short term irrational decisions; how many of us resist vices or quit soon after – we usually wait for `health signs’ (if at all) before getting serious about quitting.
Why should we assume that market participants will be rational when they have trouble adhering to rationality in their lives?
Why should we assume that they make prudent decisions in the market when they cannot be always logical in their own actions?
Why should we assume that the markets will immediately reward logical thinking, when most of our lives are not governed by logic?
So, right or wrong, I like to think even though fundamental issues surface one side of the story. For imminent market movement, technical signs and divergences in indexes, sentiment indicators, and currency arena are often more important…
Taming basic instincts (Sept 2008)
It is not how right or how wrong you are that matters, but how much money you make when right and how much you do not lose when wrong.
Events like the markets have been faced with in the last week fill me with awe. I am always cognizant of the risks in trading, and when revered companies like Lehman go bust, I step back, and reread my rules and re-commit to following them. Two things come to mind as I deviate from the usual technical commentary on the buzz.
First, unlike big trading firms, individual traders/ investors have no bosses looking over their shoulders! Unlike institutional traders, there is no enforced rule-adherence for us. We have to act as our own bosses! It is imperative to be aware of this and trade in a disciplined manner with personalized rules for position-sizes, stop losses etc. Here being a part of community should help! It is no wonder that people who join classes and groups have a better chance of achieving their goals, then people who go at it alone.
Secondly, poor account action leads to poor risk-assessment of event probability. Traders bet more aggressively if they have endured a losing streak, as many a recreational gambler will attest, that they start betting very aggressively as soon as they are down to their last few dollars. Have the probabilities changed somehow? So, if you have faced some tough days, be tougher on your trading.
Fellow traders, it is your money and while independent management is a dream come true, remember, with independence comes great responsibility.
Stocks are like people (Dec 2010)
As I end 16th year of full time trading, I find it quite ironical, that it took me years of watching the tape to realize that people have patterns too! Although basic reactions to similar stimuli are almost the same in different people, the degree to which they react could be varied. For instance, an unexpected wonderful gift would most likely evoke positive response but the extent of emotion displayed would vary.
Here’s a short story that I often share on this issue.
A passerby once saw a man get bitten by an injured scorpion, when he tried to rescue it from drowning. The man let go, but soon saved the scorpion again when it started drowning. The scorpion bit him again.
Perplexed, the passerby asked the man why he would do such a thing, when he knows he would be bitten.
The wise man replied, “It’s displaying its nature. I am showing mine.”
Key points I take away:
- Everyone has a ‘pattern’.
- People never change. (Or need a catalyst to change)
- Don’t be a scorpion BUT more importantly, it’s not a good idea to be a wise man either; don’t let a scorpion bite again. (Very important to learn this lesson in trading)
Moving away from stories, I feel that stocks are like people, in that they react similarly to a certain set of conditions, but the way they react can be gained from their personal histories. For some stocks 200-day MA is like a line in the sand, others routinely break those boundaries. Some obey their support and resistance zones, and others (especially with news risk as in Biotech stocks) don’t conform at all.
Keep your friends close but enemies closer
If a man is offered a fact which goes against his instincts, he will scrutinize it closely, and unless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he is offered something which affords a reason for acting in accordance to his instincts, he will accept it even on the slightest evidence.
Have you thought about your friends lately? Who do you closely associate with? It’s understandable that we find connections with those who resonate with our belief structure, reiterate our passions, and enhance our strengths. Having a gym-buddy or a book-club partner who likes what you like is a good way to spend time.
So, how do our chosen associations help with our outlook toward the markets? I wanted to talk about this very important factor that seriously affects trading but ironically is often relegated to the recesses — behind fundamental and technical analysis, entry and exit techniques, stop losses, and so forth. It’s far easier to share a chart of some index or discuss a stock. So why spend any time and effort on talking about the company you keep?
Well, how about the fact that it affects your macro biases toward the market, shapes your view about the trades you make, and has more lasting influence on your portfolio than one stock or index chart?
These subtle yet powerful associations are so because human beings are vulnerable to other people’s emotions. And that vulnerability is especially important if their beliefs resonate with us. This is summed up eloquently in a quote from an article called Emotional Rescue: (Team, pls link)“Although human emotions don’t spread like colds, they are contagious.”
If our bias is bullish, we’ll keep flicking through channels until we find someone who tells us what we want to hear — that the market is going much higher and it’s advisable to put all your money in it. If we have a bearish bent, we’ll scout through websites and bookmark those that enforce our already bearish beliefs, and back them with evidence we like. Even if dissenting thoughts crop up, we let them gather dust and take solace in the factual data that supports our original thesis.
The irony is that in this age of information, the thing most abundantly available is (you guessed it!) information. There are numerous blogs backing your personal thesis. No matter what we believe in, we’ll find evidence to back it. And in the markets, staunchly holding on to any one thing can lead to calamity.
For this reason, I often suggest investors stroll out of their comfort zones and add a few dissenters to their trusted friends via websites that offer opposing views, keeping in mind that you don’t have to swing the pendulum all the way. Even if the opposing views are aggravating to listen to and can turn out to be wrong, they often add depth to our perspective since we have to defend our original views.
Dissenters can give us the greatest gift of all: an open mind. This is the prerequisite for a flexible approach toward investing. As Thomas Dewar stated:
“Minds are like parachutes. They only function when they are open.”