Amid high-frequency trading and politically-driven markets, basic money management techniques should never change. None of us are right all of the time so what matters most isn't always in what you invest, but rather how you invest. Disciplined investing transcends bull and bear markets alike.
And although every investor must develop a timing and position size discipline that suits his own temperament and goals, I stick with three simple rules when buying any stock, exchange-traded fund or mutual fund.
Don't wait for a pullback
When taking a position in a stock--long or short--we're foolishly conditioned to want a bargain. So with XYZ at $19.85, for example, we may put off buying shares until we can get them under $19.50, a drop that may never come. If you actually believe shares are headed for $25 -- why quibble?
So while it at first seems counter-intuitive to buy the stock at the current price, if the anticipated "dip" does come, it's more likely a bearish, not bullish sign. We fool ourselves in to thinking a strong stock will cease its advance only long enough to drop to our ideal purchase price before reversing and heading to new highs.
Set stop limits, not price targets
When buying a stock, we often imagine how high it might rise, while rarely considering how far it might fall. Because we have a bullish bias, XYZ seems like $25 in waiting. Indeed, back in the summer of 2007, few might have imagined that AIG (AIG),
Yet as I've written before, it's not uncommon that upwards of half of all one's trades end up as losses, meaning our inclination should be towards loss limits, not price targets. Even in cases where I'm unabashedly bullish, like shipping, I plan for the worst and hope to end up surprised.
To that end, every investment one makes should immediately be followed with a stop loss limit between 13%-20% below your initial purchase price. Price targets should be skipped entirely. There are no "tops" in a bull market and, providing a stock continues to climb higher and does not grow to dominate your entire portfolio, should be kept and not traded away.
Don't create your own head games
We can't control the markets, only our exposure to them. And because XYZ is going to rise or fall regardless of how much we discuss, talk, blog or opine about it, a sound rule of thumb is to keep such distractions to a minimum. Talk about politics, sports or the economy with others, but beyond your partner and financial adviser, stew over your holdings alone.
Simply put, it unnecessarily raises the stakes. As I've often pointed out, investing requires objectivity, not a "gut feeling". The more you think about trades or talk about them, the more likely you are to feel committed to hold onto them and be proven right. "I can't sell XYZ now", you're prone to think when holding onto a stock that's fallen well below our purchase price. Emotion is influencing decisions, not the price action of the securities themselves.
Beyond the tax man, your portfolio is yours and yours alone. For a clear and level head when navigating the markets, keep it that way.—Jonathan Hoenig is managing member at Capialistpig Hedge Fund LLC