How To Avoid Disaster — And Rack Up More Winners
Most investors tend to fly by the seat of their pants. No plan or rules set in place. No discipline. It’s a formula for disaster.
And you don’t have to take my word for it…
According to Dalbar’s annual Quantitative Analysis of Investor Behavior report, the average individual investor consistently trails the S&P 500’s performance over every single period (1, 3, 5, and 20 years).
What’s more, the study identified psychological factors — not fees or taxes — as the biggest reason for the lagging performance. The real costs for individual investors are the emotional mistakes we seem to make time and time again.
Here are a few of the most common behaviors that plague investors:
Loss Aversion — The fear of loss leads to selling at the worst possible time; panic selling.
Herding — Following what everyone else is doing. This leads to “buy high/sell low.”
Mental Accounting — Separating the real performance of investments in your head to justify success and failure.
Most of these irrational behaviors can be fixed by simply implementing investment rules. But you must also have the discipline to stick to those rules, which can be difficult at times. You can bet there’ve been times I’ve wanted to hold onto a position even though my system told me to sell. But I have these rules in place expressly so I don’t make these kinds of emotional mistakes. The market does NOT care how much you or I like a particular stock.
Why You Need A System With Rules
As you may know, I write a premium newsletter for StreetAuthority called Maximum Profit. In this advisory, I employ a proprietary trading system that scours the universe of stocks to find ones that have the best potential of delivering exceptional returns in a short amount of time (my average holding period is about six months).
In Maximum Profit, we take the best of both worlds, combining a proven technical indicator with a proven fundamental analysis metric. In return we get an elite system that has the uncanny ability to find solid companies that deliver fantastic returns over a shorter amount of time.
Despite the algorithms behind the system, we keep things pretty simple. The system doesn’t get caught up with what’s happening on Capitol Hill or on Wall Street. It simply identifies what’s working and what’s not working in the market.
One of the best things about this strategy is that it helps teach investors discipline. It does this by using clear buy and sell signals, thus eliminating the emotion that often plagues investors’ performances.
To show you what I mean, here’s an amusing little chart I made a while back. It shows what the psychological cycle for most investors looks like…
If you’ve found yourself thinking these things at different points on a chart like this, you’re not alone. We’re all human, we’re all driven by emotion, and we’re all capable of doing this time and time again. Whether we can learn from our mistakes and overcome them is a different story. But if you can, then it will put you on the path to successful investing — in fact, you’ll be far ahead of the crowd.
That’s why I’m a proponent of following a system- or rule-based approach (and also why all great investors have strict investment disciplines that they follow to reduce the impact of human error).
You don’t have to have a set of algorithms at your fingertips. A system can simply be a set of guidelines that you follow. Perhaps it’s as basic as not investing outside your area of personal expertise, or as simple as having stop-losses in place. The point is that you should have some sort of game plan when it comes to investing.
What My System Is Telling Us Now
It’s no secret that the technology sector has had run the last few years. But don’t think you’ve missed the boat entirely…
My system continues to flag new tech stocks as buys. In fact, just recently, we trained our sights on the companies involved in the 5G race. And you’d be surprised what we found…
And thanks to the Maximum Profit system, my readers and I can feel reasonably confident that the stocks we find in this booming space will be winners for us in the months ahead. And that’s because our system’s track record speaks for itself.
If you’d like to learn more click here.