Experience is great teacher. In my 20 plus years of investing I’ve learned many lessons, some more painful than others. Although I don’t have any regrets from my earlier experiences, the lessons I learned below would have significantly improved my investment performance if consistently followed (as I do now).
Although, on the surface, some of these rules appear easy to follow and respect, in practice it takes lots of discipline to maintain these habits. In addition, once practiced on a consistent basis these habits can become ingrained. I hope you can take something from the list that helps improve your investing and trading results.
Lesson #1 – Be Very Patient
I still struggle sometimes with maintaining patience in entering positions. New investors often feel like they need to be “in a position or investment”. In my experience most of the money is made on the sidelines waiting patiently for a decent entry or different stock to buy. Even the best investors can succumb to the short term price action and the “fear of missing out” on a particular trade (FOMO). In order to be successful in the long-term, investors need to have the discipline to not act too quickly, for fear of missing out, as you more than often have a better opportunity to enter a trade if remaining patient.
I have made countless investments in the past, that although became ultimately profitable, would have been much more lucrative if I was patient on my entry. In many cases I could have saved 10% to 15% with a more disciplined and measured entry.
In the age of instant TV shows and movies, unlimited YouTube clips and unrestricted access to financial information and data it can be very difficult to resist the urge to move quickly on a position. Once you can master your patience and then enter positions when you don’t feel pressured to act your decision making and ultimate results will improve dramatically.
Lesson #2 – Don’t Take Advice from Others
This one is tough. 20 years ago investors would pay hundreds if not thousands of dollars for access to monthly newsletters from stock picking “experts”. Now one can visit sites like Zacks.com and SeekingAlpha.com and read unlimited and very detailed analysis from very smart investors and research professionals. However, even the most seasoned and experienced investors can get it wrong, regardless of the amount of research and data analysis performed.
“Taking advice from friends can be another quick way of losing lots of money”
Taking advice from friends can be another quick way of losing lots of money. Many people get “married” to positions and talk them up to family members and friends in hopes to reinforced their positive outlook on a particular “stock pick”. And often, because you are getting in for a “discount” to where they entered you feel like you’re getting a deal. In my experience each “tip” I took from an acquaintance did not pay off.
In order to take control and responsibility for your money and results you need to make your own decisions regardless of what experts may say that contradict your thesis. Contrary to what some might think I believe that with enough hard work, discipline and experience “regular” people can make good long-term investment decisions.
Lesson #3 – Let your Winners Run
I think this lesson can be one of the most difficult ones to learn for most new and even some experienced investors. I know it was for me. From my earlier days on the trading floor I learned how imperative it was to the long-term success and longevity of my investing career to cut my losses quickly. And although I was always disciplined in keeping my losers small I always had a tough time letting my winners run. I would close a position with a relatively decent gain only to see it double or sometimes triple from that exit. Recent studies have shown that traders and investors tend to sell their winners too quickly and hold on to their losers.
“Once I started implementing this rule on a consistent basis my investing performance improved dramatically”
Once I started implementing this rule on a consistent basis my investing performance improved dramatically. I also experienced the added benefits of less positions to manage at any given time and more time available to find additional opportunities in the market. This rule does have a considerable downside however. In some cases, holding longer term positions can result in them pulling back significantly wiping out a large unrealized gain. And we all know how painful the feeling of watching a position run up 30% just to come all the way back can be. In many cases, depending on whether I’ve develop a total position in a stock I might take profits on a portion of the position after a large move. I know that some disagree with this approach and would rather hold a position through these big swings in hopes of maintaining a profitable long-term play in a stock. For instance, trend traders like Covel will often hold through these swings and will not exit a position until the trend actually turns lower (easier said then done to recognize this shift).
Either approach can be successful and each investor will need to make exit decisions based on the particular position and their investment philosophy. However developing some discipline in holding positions that move in your favour can result in tremendous gains if managed properly.
Lesson #4 – Try to Keep Positions Uncorrelated
Although more technical, this is a great lesson to learn and should help you avoid by swings you in portfolio. Portfolio positions can be considered correlated when they are within the same industry or within a family of industries that are interdependent. Sometimes it can be tough to recognize when positions are correlated as globalization and cross border commerce can interconnected many industries and companies.
I still have some work to do with respect to my portfolio to ensure that I don’t have too many uncorrelated positions at any particular time. You’ll never have a fully uncorrelated portfolio, however if you can be mindful of which stocks in your portfolio are likely to move up and down together, and then re-calibrate some of these positions you’ll be able to smooth out the volatility of your portfolio significantly.
Lesson #5 – Scale in and out of Positions
This is something I practice in each position I open and close. In my earlier days I would always make a decision on a particular stock I wanted to buy and purchased all at once (often because of limited capital in my early days). This can certainly work, however considering your initial entry price will often be less than perfect, scaling in to a position can result in a much better average price.
In my experience this strategy also has the added benefit of ensuring you develop additional experience with a particular stock to increase your awareness of it’s movement. This will allow you to better understand when and where to get in and out.
Lesson #6 – Never get too high and never get too low
Winning trades can be awesome. When you make one you’ll be inclined to tell friends and family. Resist this urge and stay humble on each and every successful trade. I used to be super stoked about my winner and felt down when I have large losses. I’ve learned now that these are all part of the game and nothing is gained by getting too high or too low.
I’m much better now at staying a lot less emotional about trades. Losing well is a big part of trading and investing success and winning with grace is also a necessary habit to master.
Lesson #7 – You don’t have a gain until you sell
Jim Cramer tells a great story in his book “Confessions of a Street Addict” that reinforces this lesson well. He had a significant gain on a particular stock (can’t remember which) that he bragged about to his wife after picking her up from the airport one day. The next day the stock turned violently on him and he got crushed.
You truly haven’t made money on a stock until you actually close the position. Therefore I don’t assume any of my unrealized gains are actually profits until harvested. Keeping this in mind will help you maintain context on your actual performance.
Hopefully some of the lessons above can be helpful to some of our younger trader and investing colleagues. As with most things in life, we should continue learning from our failures while ensuring we properly manage our successes.