In the markets, just as in life, we usually end up finding what we go looking for. And the problem with most traders is that they're seeking the rush of speculation. They like to buy and sell investments more than they like to make money.
The investment newsletter business and most financial TV shows are built around this undisputable fact. Stock tips are the market's glucose: there's an inherent thrill, even with small dollars at stake, in buying a stock and watching it rise or fall. Like the alcoholic who can't have just one drink, we seek out that pleasure over and over and over again.
But making money in the markets doesn't come from trading. There's no correlation between the number of transactions and how much money one makes. In fact, it's the holding, not the trading, where the money is actually made.
Yet holding a winner isn't very exciting at all, which is why so many of us loathe to sell when we should. We buy a stock and it rises, and the moment the profit exceeds the cost of a McDonald's value meal or even our own commissions, we grab the gains, content to snatch a "win" -- any win -- and move on to another exciting score. (Also see, "How McDonald's Stock Still Tastes Good.")
Yet one's success isn't determined by the total number of winning trades, but by the size of the profits relative to the inevitable losses every trader by definition must take.
The downfall with snatching wins is that you immediately cut them short, removing yourself from an open, winning trade: the only means by which a profit is possible. If making money is your goal, you'd opt to keep winning positions, not toss them aside.
And while every trade could be an opportunity, it's most certainly a risk: each new idea is one that has the potential to blow up in our face. This is why an existing, winning and open position (the kind we tend to mistakenly trade away) is incalculably more valuable than a new pick. Profitable trades tend to stay profitable, while untried speculations are always more of a crapshoot.
Yet "traders" anxious to make transactions tend to give away the higher probability positions with peanut sized-profits while seeking out untested ideas with much less chances for success. It's not hard to see how this quickly becomes a losing formula.
In reality, the trades one should most often make involve taking losses, not grabbing gains, despite the fact it's a painful experience we instinctually want to avoid. As a result, many portfolios end up losing by dragging around names like Cisco (CSCO),
On the rare occasion losers finally do rally into the black, we trade them away at the first possible moment they show a profit. Why? Because we've got a winner. The wealth-destroying trading instinct strikes again.
For the undeniable thrill of buying and selling, there's eBay (EBAY), Craigslist, online poker or small-stakes foreign exchange. But if profit, not excitement, is your goal, experience suggests its permitting winning ideas to play out, as opposed to trading them away, where the actual money is made.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC (Http://www.capitalistpig.com)