In the markets>, a few simple steps can help keep one s emotions at bay.
We don t just battle the markets, but our own emotional stability and mental health. Open trades are a relentless feedback loop. For six-and-a-half hours a day, at a minimum, you get a real-time reading of how smart or idiotic you may be, and markets don t discriminate based on experience, expertise or net worth. No matter what level you play the game, when you re wrong, its agony, and when you re right, it s like getting a kiss from the world s most beautiful girl.
We always point out that losing positions, while painful, actually provide a benefit in giving an immediate indication of which strategies aren t working. Nobody likes losing money. But a small loss, if handled appropriately, is normal and perfectly manageable. Nobody is right all the time.
Where the wheels go off the track is it s no longer our heads making investment decisions, but our hearts. Emotional investing never ends well.
So we have a fight with our significant other and decide to sell our winners to boost our spirits. Or we get bored with our mutual funds and decide to dive into leveraged exchange-traded funds for more action. Unsatisfied with our own performance, we double down on losing trades in the hopes a small pop will put us back to even. In my experience, all will set you back more money than the best therapist money can buy.
Given the stressors of investing, there are a few simple tricks to ensure your decisions are being made based on the economic realities of your portfolio not your emotional stability.
Stash Some Cash
There s nothing particularly exciting about an emergency fund, the six to 12 months worth of living expenses every investor should have stashed away in a money-market or savings account. It s even less thrilling when you re earning nearly nothing on that cash.
Yet like fire insurance, an emergency fund is beneficial even if you never end up using it. Investment involves risk; any potential for profit comes along with the possibility of a loss. The emergency fund makes you, in effect, a much stronger hand in the marketplace. Risk is much easier to face when you know that month s mortgage payment or gas bill isn t riding on shares of iShares FTSE/Xinhua China 25 Index.
Keep Your Cool
In many states, you can t simply walk into a gun store and walk out with a pistol. Local and federal laws mandate waiting or cooling off period to diffuse any immediate -- and potentially dangerous rush someone might have to use a firearm.
No similar restrictions exist for investments. And while emotional decision making can t take anybody s life, it can quickly wreck his or her portfolio.
In the heat of the trading day, it s very easy to feel pressured to reallocate assets, either to jump on momentarily hot trend or dump existing holdings. As a young amateur investor, I embarrassingly recall mornings in which I d wake up and learn about a company on CBNC and have already bought hundreds of shares for my portfolio before the end of "Live with Regis and Kathy Lee." That s not investing. It s craps.
When you trade for the big moves, and not the short-term scalps, it s rare a portfolio allocation must be made at that very instant an idea pops into your mind. This is where a cooling off period can help you keep your head.
So, at the very least, I advocate taking a short breather or walk about the block before making monumental changes to your portfolio, especially when it comes to adding new positions. When you re frustrated and hungry to win, there s an emotional temptation to throw on a few shares of anything that s moving the hour you happen to switch on your screen. Even a few moments consideration can help to determine if the trade is being considered out of profit-seeking self interest or boredom.
When it comes to exiting trades, I advocate controlling my emotions by using stop loss orders pre-set below the current market price that will be triggered regardless of my emotional state. I know that, for whatever reason, I ll sell XYZ should it drop 20% from my purchase price. It s almost a relief to have that burden lifted off one shoulders.
When Less Is More
Finally, although it might seem counterintuitive, one effective means of controlling our emotions about an investment is to avoid learning too much about it.
Sounds crazy? In reality, what we trade what matters -- is the stock price itself. And after spending hours researching, evaluating and immersing yourself in one particular company, it s easy to become enamored while completely missing the actual price action of the market itself.
Sirius, which peaked near $70 a share in 2000 and fell as low as five cents earlier this year, provides an excellent example. Many shareholders fans of both Howard Stern and the radio service, held the stock the whole way down over nearly nine years.
Stocks are not companies they are simply pieces of paper. And the more annual reports we read and conference calls we monitor, the more likely we are to give a losing trade the undeserved benefit of the doubt.
Don t think of an investment as a relationship but a business transaction. When a new cell phone company comes along and offers a more cost-effective plan, more of us don t hesitate to kick our current carrier to the curb. The same dispassionate and unflappable approach should be brought to bear when it comes to shares of XYZ.