Do Fear and Greed Guide Your Decisions?
Posted: Sat Nov 08, 2008 8:22 pm
Do Fear and Greed Guide Your Decisions?
Stockscores.com Perspectives for the week ending November 8, 2008
I read a newspaper article this week about the record amount of money that came out of Mutual Funds in the month of October. Never had so much capital been taken out of the market before.
This makes perfect sense, right? Is it not wise to sell everything when prices are low?
The stock market told us to sell in the summer time when major areas of support were broken. Most people ignored that, either because they did not know what to look for or because the headlines were still generally positive. Waiting to sell in October was sort of like waiting for your house to burn down before putting it on the market.
But that is the way most people think because fear and greed guide their decisions. Once the market has gone up a lot and the headlines are positive again, the money will come back.
Here are 10 things you can do to become a better investor and avoid these traps:
1. Use Strategies that Work
Your approach to the market won't have a hope if your analysis methods are not effective. There are many ways to analyze stocks, take one that you like and test it until you have confidence that it works.
2. Write a Trading Plan
Success has a better chance of happening when you write down a plan to get there. Make your plan include your rules for entry and exit, risk tolerances and a process for review. Adapt your plan over time as you find better ways to achieve success.
3. Manage Risk
Understand the risk in every trade you make and don't take risks that you can not tolerate. If your exposure to loss is more than you are comfortable with you will inevitably break your discipline.
4. Limit Losses
You should always know where the exit door is in case something goes wrong. When you buy a stock, decide the point where the market will have proven your decision to enter wrong. If the stock falls to that price, get out. Don't let small losses grow in to big losses.
5. Blame Yourself
There may be a good argument for why a loss you have suffered is someone else's fault. The newsletter writer could have been wrong, the media could have been wrong, the government could have gone back on a promise, the company could be corrupt. Blaming others will never get your money back. You will not change the actions of others, you can only change your own. Therefore, blame yourself for everything that happens with your money and take steps to make it better.
6. Stop Falling in Love
The more you know about a company, the more likely you are to ignore the market's message. Companies want you to own their stock; the more investors that they get to own their stock, the higher the price goes. As a result, there is a bias to the information that you are exposed to, if you listen too much you may miss activity in the market that is telling you that something is wrong.
7. Practice Patience
Up trends start slowly so you have to be patient when stocks are trying to start a long term trend. The profit is in the patience, hold on to strong stocks so long as they are showing strength. When looking at a company, avoid a short term outlook that can mislead you about the long term trend.
8. See the Other Side of the Story
Everything you know about a stock may tell you to buy it and you may do so with complete commitment. But, always ask yourself, "Why is someone willing to sell to me at this price." If you understand their motivations for selling versus your motivations for buying, you can better determine who is right. Without an understanding of the other side of the trade you can not determine whether the other side is wrong.
9. Avoid the Herd
The crowd usually loses. When buying, look around at your fellow buyers. Are they well informed, smart investors or are they generally uninformed people watching 60 Minutes? Always try to be one step ahead of the herd.
10. Analyze Your Results
The market is always evolving, making constant evolution in your approach to the markets important. On a regular basis, analyze your trades and looks for patterns of self destruction. Make changes as necessary.
Stockscores.com Perspectives for the week ending November 8, 2008
I read a newspaper article this week about the record amount of money that came out of Mutual Funds in the month of October. Never had so much capital been taken out of the market before.
This makes perfect sense, right? Is it not wise to sell everything when prices are low?
The stock market told us to sell in the summer time when major areas of support were broken. Most people ignored that, either because they did not know what to look for or because the headlines were still generally positive. Waiting to sell in October was sort of like waiting for your house to burn down before putting it on the market.
But that is the way most people think because fear and greed guide their decisions. Once the market has gone up a lot and the headlines are positive again, the money will come back.
Here are 10 things you can do to become a better investor and avoid these traps:
1. Use Strategies that Work
Your approach to the market won't have a hope if your analysis methods are not effective. There are many ways to analyze stocks, take one that you like and test it until you have confidence that it works.
2. Write a Trading Plan
Success has a better chance of happening when you write down a plan to get there. Make your plan include your rules for entry and exit, risk tolerances and a process for review. Adapt your plan over time as you find better ways to achieve success.
3. Manage Risk
Understand the risk in every trade you make and don't take risks that you can not tolerate. If your exposure to loss is more than you are comfortable with you will inevitably break your discipline.
4. Limit Losses
You should always know where the exit door is in case something goes wrong. When you buy a stock, decide the point where the market will have proven your decision to enter wrong. If the stock falls to that price, get out. Don't let small losses grow in to big losses.
5. Blame Yourself
There may be a good argument for why a loss you have suffered is someone else's fault. The newsletter writer could have been wrong, the media could have been wrong, the government could have gone back on a promise, the company could be corrupt. Blaming others will never get your money back. You will not change the actions of others, you can only change your own. Therefore, blame yourself for everything that happens with your money and take steps to make it better.
6. Stop Falling in Love
The more you know about a company, the more likely you are to ignore the market's message. Companies want you to own their stock; the more investors that they get to own their stock, the higher the price goes. As a result, there is a bias to the information that you are exposed to, if you listen too much you may miss activity in the market that is telling you that something is wrong.
7. Practice Patience
Up trends start slowly so you have to be patient when stocks are trying to start a long term trend. The profit is in the patience, hold on to strong stocks so long as they are showing strength. When looking at a company, avoid a short term outlook that can mislead you about the long term trend.
8. See the Other Side of the Story
Everything you know about a stock may tell you to buy it and you may do so with complete commitment. But, always ask yourself, "Why is someone willing to sell to me at this price." If you understand their motivations for selling versus your motivations for buying, you can better determine who is right. Without an understanding of the other side of the trade you can not determine whether the other side is wrong.
9. Avoid the Herd
The crowd usually loses. When buying, look around at your fellow buyers. Are they well informed, smart investors or are they generally uninformed people watching 60 Minutes? Always try to be one step ahead of the herd.
10. Analyze Your Results
The market is always evolving, making constant evolution in your approach to the markets important. On a regular basis, analyze your trades and looks for patterns of self destruction. Make changes as necessary.