10 Tips For The Successful Long-Term Investor
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)
While it may be true that in the stock market there is no rule without an exception, there are some principles that are tough to dispute. Let's review 10 general principles to help investors get a better grasp of how to approach the market from a long-term view. Every point embodies some fundamental concept every investor should know.
1. Sell the losers and let the winners ride!
Time and time again, investors take profits by selling their appreciated investments, but they hold onto stocks that have declined in the hope of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice. The following information might help:
* Riding a Winner - Peter Lynch was famous for talking about "tenbaggers", or investments that increased tenfold in value. The theory is that much of his overall success was due to a small number of stocks in his portfolio that returned big. If you have a personal policy to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever had a tenbagger. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting. (For more insight, see Pick Stocks Like Peter Lynch.)
* Selling a Loser - There is no guarantee that a stock will bounce back after a protracted decline. While it's important not to underestimate good stocks, it's equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses. (For related reading, check out To Sell Or Not To Sell.)
2. Don't chase a "hot tip".
Whether the tip comes from your brother, your cousin, your neighbor or even your broker, you shouldn't accept it as law. When you make an investment, it's important you know the reasons for doing so: do your own research and analysis of any company before you even consider investing your hard-earned money. Relying on a tidbit of information from someone else is not only an attempt at taking the easy way out, it's also a type of gambling. Sure, with some luck, tips sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run. (Find what you should pay attention to - and what you should ignore in Listen To The Markets, Not Its Pundits.)
3. Don't sweat the small stuff.
As a long-term investor, you shouldn't panic when your investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term. Also, don't overemphasize the few cents difference you might save from using a limit versus market order.
Granted, active traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself. (Learn the difference between passive investing and apathy in Ostrich Approach To Investing A Bird-Brained Idea.)
4. Don't overemphasize the P/E ratio.
Investors often place too much importance on the price-earnings ratio (P/E ratio). Because it is one key tool among many, using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is overvalued. (For further reading, see our tutorial Understanding the P/E Ratio.)
5. Resist the lure of penny stocks.
A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you've lost 100% of your initial investment. A lousy $5 company has just as much downside risk as a lousy $75 company. In fact, a penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it. (For further reading, see The Lowdown on Penny Stocks.)
6. Pick a strategy and stick with it.
Different people use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick with it. An investor who flounders between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors should avoid. Take Warren Buffett's actions during the dotcom boom of the late '90s as an example. Buffett's value-oriented strategy had worked for him for decades, and - despite criticism from the media - it prevented him from getting sucked into tech startups that had no earnings and eventually crashed. (Want to adopt the Oracle of Omaha's investing style? See Think Like Warren Buffett.)
7. Focus on the future.
The tough part about investing is that we are trying to make informed decisions based on things that are yet to happen. It's important to keep in mind that even though we use past data as an indication of things to come, it's what happens in the future that matters most.
A quote from Peter Lynch's book "One Up on Wall Street" (1990) about his experience with Subaru demonstrates this: "If I'd bothered to ask myself, 'How can this stock go any higher?' I would have never bought Subaru after it already went up twentyfold. But I checked the fundamentals, realized that Subaru was still cheap, bought the stock, and made sevenfold after that." The point is to base a decision on future potential rather than on what has already happened in the past. (For more insight, see The Value Investor's Handbook.)
8. Adopt a long-term perspective.
Large short-term profits can often entice those who are new to the market. But adopting a long-term horizon and dismissing the "get in, get out and make a killing" mentality is a must for any investor. This doesn't mean that it's impossible to make money by actively trading in the short term. But, as we already mentioned, investing and trading are very different ways of making gains from the market. Trading involves very different risks that buy-and-hold investors don't experience. As such, active trading requires certain specialized skills.
Neither investing style is necessarily better than the other - both have their pros and cons. But active trading can be wrong for someone without the appropriate time, financial resources, education and desire. (For further reading, see Defining Active Trading.) Most people don't fit into this category.
9. Be open-minded.
Many great companies are household names, but many good investments are not household names. Thousands of smaller companies have the potential to turn into the large blue chips of tomorrow. In fact, historically, small-caps have had greater returns than large-caps: over the decades from 1926-2001, small-cap stocks in the U.S. returned an average of 12.27% while the Standard & Poor's 500 Index (S&P 500) returned 10.53%.
This is not to suggest that you should devote your entire portfolio to small-cap stocks. Rather, understand that there are many great companies beyond those in the Dow Jones Industrial Average (DJIA), and that by neglecting all these lesser-known companies, you could also be neglecting some of the biggest gains. (For more on investing in small caps, see Small Caps Boast Big Advantages.)
10. Be concerned about taxes, but don't worry.
Putting taxes above all else is a dangerous strategy, as it can often cause investors to make poor, misguided decisions. Yes, tax implications are important, but they are a secondary concern. The primary goals in investing are to grow and secure your money. You should always attempt to minimize the amount of tax you pay and maximize your after-tax return, but the situations are rare where you'll want to put tax considerations above all else when making an investment decision (see Basic Investment Objectives).
Conclusion
In this article, we've covered 10 solid tips for long-term investors. There is are exceptions to every rule, but we hope that the common-sense principles we've discussed benefit you overall and provide some insight into how you should think about investing.
by Investopedia Staff, (Contact Author Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.
** This article and more are available at Investopedia.com - Your Source for Investing Education **
http://www.investopedia.com/articles/00/082100.asp
Friday 4 September 2009
Thursday 3 September 2009
Analab
3.9.09
NAV 1.94
No of Shares 60.02 m
Equity 115.1 m
Cash and Cash Equivalent 32.27 m ( 0.538/share)
Investment in Equity 15.83 m (0.263/share)
Earnings (after tax) 9.37 m (0.156/share)
Dividend 0.045/share (gross)
ROE 8.13%
Today's share price 1.02/share
DY 4.4% (gross) 3.1% (net)
PE 6.53
Market cap 61.22 m
Last 5 years (2005 - 2009)
Total EPS 0.571
Dividend 0.1205
DPO 21%
So many questions to ask of the management?
1. Why is the management of this company hoarding so much cash?
2. Will this cash be employed more productively in the future?
3. Why is the management investing 15.83m into equity?
4. Why not return the surplus cash to the shareholders?
5. Why is the company paying such miserable dividends when it can well afford to be more generous? A reasonable company should pay around 30 to 70% of earnings as dividend.
6. The present ROE of 8.13% isn't great and does not lend support to the management retaining so much earnings each year.
7. Why is the management not taking heed of the investors of this stock?
This is a company with reasonable business revenues and earnings. However, the management has erred in its role as the steward of the company on behalf of the shareholders. The minority shareholders are not adequately rewarded. The return is not decent enough, therefore its share price is trading at a huge discount to its NAV.
A value investor maybe tempted to buy this stock. Moreover, it gives a dividend yield of 3% and if one can wait (BIG IF) for the value of the shares to realise its fair value, that's fine.
The risk is that this company will continues to be managed thus, giving miserable dividends, and hoarding cash which are employed at a low ROE for many years until one fine day, the majority shareholders decide the market price should be higher. Without being able to persuade or influence these important decisions, should you put your money into this stock?
NAV 1.94
No of Shares 60.02 m
Equity 115.1 m
Cash and Cash Equivalent 32.27 m ( 0.538/share)
Investment in Equity 15.83 m (0.263/share)
Earnings (after tax) 9.37 m (0.156/share)
Dividend 0.045/share (gross)
ROE 8.13%
Today's share price 1.02/share
DY 4.4% (gross) 3.1% (net)
PE 6.53
Market cap 61.22 m
Last 5 years (2005 - 2009)
Total EPS 0.571
Dividend 0.1205
DPO 21%
So many questions to ask of the management?
1. Why is the management of this company hoarding so much cash?
2. Will this cash be employed more productively in the future?
3. Why is the management investing 15.83m into equity?
4. Why not return the surplus cash to the shareholders?
5. Why is the company paying such miserable dividends when it can well afford to be more generous? A reasonable company should pay around 30 to 70% of earnings as dividend.
6. The present ROE of 8.13% isn't great and does not lend support to the management retaining so much earnings each year.
7. Why is the management not taking heed of the investors of this stock?
This is a company with reasonable business revenues and earnings. However, the management has erred in its role as the steward of the company on behalf of the shareholders. The minority shareholders are not adequately rewarded. The return is not decent enough, therefore its share price is trading at a huge discount to its NAV.
A value investor maybe tempted to buy this stock. Moreover, it gives a dividend yield of 3% and if one can wait (BIG IF) for the value of the shares to realise its fair value, that's fine.
The risk is that this company will continues to be managed thus, giving miserable dividends, and hoarding cash which are employed at a low ROE for many years until one fine day, the majority shareholders decide the market price should be higher. Without being able to persuade or influence these important decisions, should you put your money into this stock?
The difference between the buy and sell transactions is profit.
I. BUY LOW, SELL HIGH
The idea of "buy low, sell high" is as old as trading ownership of properties. It is the basis of all business. Buy a property at one price and sell it at a higher price. The difference between the buy and sell transactions is profit. To make a profit is the reason to buy and sell stock.
When the investor first heard about the takeover, it was already late in the game to make a play. Thinking for a day or two about buying or selling can sometimes be disastrous. The investor sold out the position without learning the details.
Once a strategy is put in play, an investor should not be so quick to change. The investor should have checked the background on the two companies. The 10 percent loss strategy is just that, a 10 percent loss. It has nothing to do with how a price will perform in the next few days. Some professional investors look for stocks that are down 10 to 15 percent and consider them buying opportunities. They know the 10 percent will be bailing out and the stock prices can become even better bargains. These investors will allow a 10, 15 or even 20 percent drop because the majority of buyers did not buy at the top.
If an investor is going to speculate on takeovers, it is important that he or she realize that the prices will tend to be volatile until the actual takeover occurs.
The axiom "buy low, sell high" should not be followed in reverse by the investor.
II. BUY HIGH, SELL HIGHER
Many individuals are attempting to "buy high and sell higher" when they buy a stock that is on the move. In fact, professional traders frequently use the strategy. Soaring prices are attractive to investors, who believe the prices will keep moving. As long as the momentum of the price swing attracts new buyers, the soaring stock price will continue to climb. It might run up for a couple of days, weeks or even months. Eventually, however, there is a hesitation, followed by a turn as the profit taking begins. The last buyers not only have the smallest gains from the run up, they will obviously also have the biggest losses. It is somewhat like a pyramid scheme where the losers are the last to join.
A severe market decline creates lower prices and large cash positions even though the earnings of stocks can remain unchanged. The bargains can be resisted for only a limited time. In a severe market decline, the climb back to former levels could take a few months or longer, but the recovery will come in time.
Where are the plays?
Individual investors can seek out stocks that are either in play by the institutions or are likely to come into play. Often they are stocks with strong fundamentals in earnings and revenues, found in industries with good growth potential. Medical products and devices can be exciting fast growth companies. Sometimes older products companies with strong growth records do well.
Enhancements
The strategy of buy high, sell higher can be enhanced by anticipated increases in earnings or by corporate takeover situations. Although anticipation of higher earnings creates unusually high ratios, when the earnings do increase, the ratios return to normal levels. If the earnings do not cause a return to normal levels, sellers will eventually force the return.
Takeovers
Corporate takeovers create a different situation. Professional arbitrageurs go on search missions in which they look specifically for companies likely to be bought out by some other company. The large leveraged buyout takeover can become a classic buy high, sell higher situation. For those companies who could arrange the deals, there was less risk with greater profits.
Long-term intention
Buying high and selling higher can be a visible way to make money in the stock market, but it is not without risk. The strategy usually calls for the intention of a longer term hold for example, when the earnings cannot catch up with the price or in a takeover, when the deal is finalized. Although it is possible to trade in and out during volatile times, the whip-saw effects of being on the wrong side can be devastating.
Corporate takeovers that fail to materialize are a different story. If a buyout does not occur, the stock price will probably fall to previous levels or below. Most often, investors would be prudent to sell and take the loss quickly, rather than hang on and hope for a recovery. A prudent play after selling out can be to attempt bottom fishing once the price gets hammered. Such activity should be based on the individual's belief that the stock can weather the storm and that the company is still capable of generating good earnings.
It would not be unusual for institutional or other experienced stock traders to play these stocks for small profits. They might sell short at the peaks and attempt to buy long at the lows. Such actions often end up to be momentum oriented. They watch the trades minute by minute to see if there is any strength as shown by volume. If strength is indicated by larger volume, they hold their position. If the volume declines, they close out their positions and plan their next strategy. Obviously, timing is everything in these speculative strategies.
Long or short term
Buy high, sell higher can work for either the conservative long-term or speculative short-term, strategy. But what either strategy needs is a stock that has a solid reason to go higher in price. Two of the main reasons for a stock price to go higher are anticipated higher earnings or a takeover plan.
III. SELL HIGH, BUY LOW
Sell short at a high price and buy back at a lower price. Wonderful, an investor can make money in a falling market.
Limited gain
A short position can profit only to the amount that a price drops. But in a short position, there is virtually unlimited risk because there is no limit to how high a stock price can go. Eventually, the shares must be bought back or if the investor currently owns the shares, delivered to cover the short position. The potential problem is that if the price does not fall, it might rise higher than the investor can afford to pay.
IV. SELL THE LOSERS AND LET THE WINNERS RUN
It is one of the most important understandings an investor can have about the stock market. It is prudent for an investor to sell stocks that are losing money, stocks that could continue to drop in price and value. It makes equally good sense to stay with stocks that show significant gains, as long as they remain fundamentally strong.
Any price drop is a losing situation. Price drops cost the investor money. They are a loss of profits. In some circumstances the investor should sell, but in other situations the investor should take a closer look before reaching a sell decision.
The determination of whether a stock is still a winner depends on the cause of the price correction. If a price drop occurs because of a weakness in the overall market situation or is the result of a normal daily fluctuation of the stock price, the stock can still be a winner.
If, however, the cause of the drop has long term implications, it could be time to take the loss and move on to another stock. Long term implications could be any of the following:
1 Declining sales
2 Tax difficulties
3 Legal problems
4 An emerging bear market
5 Higher interest rates
6 Negative impacts on future earnings
Any event that has a negative impact on the long term picture of earnings or earnings growth can quickly turn a stock into a loser. Many long and short term investors will sell out their positions and move on to a potential winner.
http://www.omniglot.com/info-articles/dallas/buy_market_price_sell_stock.html
The idea of "buy low, sell high" is as old as trading ownership of properties. It is the basis of all business. Buy a property at one price and sell it at a higher price. The difference between the buy and sell transactions is profit. To make a profit is the reason to buy and sell stock.
When the investor first heard about the takeover, it was already late in the game to make a play. Thinking for a day or two about buying or selling can sometimes be disastrous. The investor sold out the position without learning the details.
Once a strategy is put in play, an investor should not be so quick to change. The investor should have checked the background on the two companies. The 10 percent loss strategy is just that, a 10 percent loss. It has nothing to do with how a price will perform in the next few days. Some professional investors look for stocks that are down 10 to 15 percent and consider them buying opportunities. They know the 10 percent will be bailing out and the stock prices can become even better bargains. These investors will allow a 10, 15 or even 20 percent drop because the majority of buyers did not buy at the top.
If an investor is going to speculate on takeovers, it is important that he or she realize that the prices will tend to be volatile until the actual takeover occurs.
The axiom "buy low, sell high" should not be followed in reverse by the investor.
II. BUY HIGH, SELL HIGHER
Many individuals are attempting to "buy high and sell higher" when they buy a stock that is on the move. In fact, professional traders frequently use the strategy. Soaring prices are attractive to investors, who believe the prices will keep moving. As long as the momentum of the price swing attracts new buyers, the soaring stock price will continue to climb. It might run up for a couple of days, weeks or even months. Eventually, however, there is a hesitation, followed by a turn as the profit taking begins. The last buyers not only have the smallest gains from the run up, they will obviously also have the biggest losses. It is somewhat like a pyramid scheme where the losers are the last to join.
A severe market decline creates lower prices and large cash positions even though the earnings of stocks can remain unchanged. The bargains can be resisted for only a limited time. In a severe market decline, the climb back to former levels could take a few months or longer, but the recovery will come in time.
Where are the plays?
Individual investors can seek out stocks that are either in play by the institutions or are likely to come into play. Often they are stocks with strong fundamentals in earnings and revenues, found in industries with good growth potential. Medical products and devices can be exciting fast growth companies. Sometimes older products companies with strong growth records do well.
Enhancements
The strategy of buy high, sell higher can be enhanced by anticipated increases in earnings or by corporate takeover situations. Although anticipation of higher earnings creates unusually high ratios, when the earnings do increase, the ratios return to normal levels. If the earnings do not cause a return to normal levels, sellers will eventually force the return.
Takeovers
Corporate takeovers create a different situation. Professional arbitrageurs go on search missions in which they look specifically for companies likely to be bought out by some other company. The large leveraged buyout takeover can become a classic buy high, sell higher situation. For those companies who could arrange the deals, there was less risk with greater profits.
Long-term intention
Buying high and selling higher can be a visible way to make money in the stock market, but it is not without risk. The strategy usually calls for the intention of a longer term hold for example, when the earnings cannot catch up with the price or in a takeover, when the deal is finalized. Although it is possible to trade in and out during volatile times, the whip-saw effects of being on the wrong side can be devastating.
Corporate takeovers that fail to materialize are a different story. If a buyout does not occur, the stock price will probably fall to previous levels or below. Most often, investors would be prudent to sell and take the loss quickly, rather than hang on and hope for a recovery. A prudent play after selling out can be to attempt bottom fishing once the price gets hammered. Such activity should be based on the individual's belief that the stock can weather the storm and that the company is still capable of generating good earnings.
It would not be unusual for institutional or other experienced stock traders to play these stocks for small profits. They might sell short at the peaks and attempt to buy long at the lows. Such actions often end up to be momentum oriented. They watch the trades minute by minute to see if there is any strength as shown by volume. If strength is indicated by larger volume, they hold their position. If the volume declines, they close out their positions and plan their next strategy. Obviously, timing is everything in these speculative strategies.
Long or short term
Buy high, sell higher can work for either the conservative long-term or speculative short-term, strategy. But what either strategy needs is a stock that has a solid reason to go higher in price. Two of the main reasons for a stock price to go higher are anticipated higher earnings or a takeover plan.
III. SELL HIGH, BUY LOW
Sell short at a high price and buy back at a lower price. Wonderful, an investor can make money in a falling market.
Limited gain
A short position can profit only to the amount that a price drops. But in a short position, there is virtually unlimited risk because there is no limit to how high a stock price can go. Eventually, the shares must be bought back or if the investor currently owns the shares, delivered to cover the short position. The potential problem is that if the price does not fall, it might rise higher than the investor can afford to pay.
IV. SELL THE LOSERS AND LET THE WINNERS RUN
It is one of the most important understandings an investor can have about the stock market. It is prudent for an investor to sell stocks that are losing money, stocks that could continue to drop in price and value. It makes equally good sense to stay with stocks that show significant gains, as long as they remain fundamentally strong.
Any price drop is a losing situation. Price drops cost the investor money. They are a loss of profits. In some circumstances the investor should sell, but in other situations the investor should take a closer look before reaching a sell decision.
The determination of whether a stock is still a winner depends on the cause of the price correction. If a price drop occurs because of a weakness in the overall market situation or is the result of a normal daily fluctuation of the stock price, the stock can still be a winner.
If, however, the cause of the drop has long term implications, it could be time to take the loss and move on to another stock. Long term implications could be any of the following:
1 Declining sales
2 Tax difficulties
3 Legal problems
4 An emerging bear market
5 Higher interest rates
6 Negative impacts on future earnings
Any event that has a negative impact on the long term picture of earnings or earnings growth can quickly turn a stock into a loser. Many long and short term investors will sell out their positions and move on to a potential winner.
http://www.omniglot.com/info-articles/dallas/buy_market_price_sell_stock.html
Five sure-fire ways to lose lots of money in the stock market.
How to Lose in the Stock Market
This might seem a strange title for me to use in a newsletter. However, it is often just as instructive to look at why people lose, as it is to identify the traits of winners. I have found that if you control losses when trading, the profits will tend to look after themselves. In a similar way, it seems to me that if I could only tell beginners what the destructive behaviours are before they start, they might be spared much financial pain. Here is a list of ways people set about losing money in the stock market:
1. Buy a Computerised Trading System
The more expensive it is, the better it will be. Quality costs in this area as in any other. Be impressed with the simulated profit results, which the promoter will assure you are a far better guide to future results than actual audited trading results. Why spend time developing yourself as a trader if you can just buy all the experience on a CD and run it on your computer? Continue to be amazed that professional fund managers don’t use these systems when the simulated results give results ten times better than mutual fund returns. When you say your prayers, don’t forget to give thanks to the generosity of the system promoter in giving you the tools to become rich quickly without risk or hard work.
2. Do It Now! Don’t Waste Time Developing a Plan of Action
After all, everyone knows that he who hesitates is lost. If only you had bought Cochlear, Flight Centre, Westfield Holdings and CSL when they listed you would be very rich now. Anyone can look at these charts and see how easy it was. The problem with most people is that they know too much about it and confuse themselves. Yes, you know that most small businesses fail and that the key reason is the lack of a sound business plan. And yes, most traders fail for the same reason – lack of a sound trading plan. But you are not like those people, you are special and would not make those silly mistakes. Plans only inhibit you. It is better for an intelligent person like you to form your plans as you go along.
3. Learn to Pick the Tops and Bottoms
Trading with the trend is for wimps. No wonder they don’t become rich, they leave too much on the table. You can capture it all – buy the low of the trend and sell the high. Look at the charts they show you at the expensive seminars run by trading gurus. Yes, buying a new low is trading against the trend, but you know when the trend is going to change – it always worked in the seminar examples. So, give thanks in your prayers for the guru who took time out from spending his or her fabulous wealth gained from trading to tell you the secret.
4. Take Profits quickly and hold on to the Losers
It is no wonder traders lose. They keep leaving their winnings on the table where the market can grab them back. They are just greedy. Better to take them straight away. Little fish are sweet and you can always catch lots more. But not the losers - after all, a loss is not real until you sell. Besides, the experts tell you stocks always go higher after a fall. Of course, you would not be silly enough to buy HIH, One.Tel or Harris Scarfe.
5. Look to Trading to Provide the Action you Crave
The trouble with most jobs and occupations is that they are boring. Bosses and clients keep wanting to impose discipline on you. But discipline breeds mediocrity. To succeed, you only need get free of all those irksome restrictions. Who needs plans? Who needs to study and learn dreary details? Who needs to have to keep good records – make money and it looks after itself. No, the market is a way to get free of all the things that have always held you back. Go for it and the devil take the hindmost.
So, there you have it – five sure-fire ways to lose lots of money in the stock market.
http://www.bwts.com.au/download/redir/015-229cbe1fa45d50d9186c7357e9edddc4.pdf
This might seem a strange title for me to use in a newsletter. However, it is often just as instructive to look at why people lose, as it is to identify the traits of winners. I have found that if you control losses when trading, the profits will tend to look after themselves. In a similar way, it seems to me that if I could only tell beginners what the destructive behaviours are before they start, they might be spared much financial pain. Here is a list of ways people set about losing money in the stock market:
1. Buy a Computerised Trading System
The more expensive it is, the better it will be. Quality costs in this area as in any other. Be impressed with the simulated profit results, which the promoter will assure you are a far better guide to future results than actual audited trading results. Why spend time developing yourself as a trader if you can just buy all the experience on a CD and run it on your computer? Continue to be amazed that professional fund managers don’t use these systems when the simulated results give results ten times better than mutual fund returns. When you say your prayers, don’t forget to give thanks to the generosity of the system promoter in giving you the tools to become rich quickly without risk or hard work.
2. Do It Now! Don’t Waste Time Developing a Plan of Action
After all, everyone knows that he who hesitates is lost. If only you had bought Cochlear, Flight Centre, Westfield Holdings and CSL when they listed you would be very rich now. Anyone can look at these charts and see how easy it was. The problem with most people is that they know too much about it and confuse themselves. Yes, you know that most small businesses fail and that the key reason is the lack of a sound business plan. And yes, most traders fail for the same reason – lack of a sound trading plan. But you are not like those people, you are special and would not make those silly mistakes. Plans only inhibit you. It is better for an intelligent person like you to form your plans as you go along.
3. Learn to Pick the Tops and Bottoms
Trading with the trend is for wimps. No wonder they don’t become rich, they leave too much on the table. You can capture it all – buy the low of the trend and sell the high. Look at the charts they show you at the expensive seminars run by trading gurus. Yes, buying a new low is trading against the trend, but you know when the trend is going to change – it always worked in the seminar examples. So, give thanks in your prayers for the guru who took time out from spending his or her fabulous wealth gained from trading to tell you the secret.
4. Take Profits quickly and hold on to the Losers
It is no wonder traders lose. They keep leaving their winnings on the table where the market can grab them back. They are just greedy. Better to take them straight away. Little fish are sweet and you can always catch lots more. But not the losers - after all, a loss is not real until you sell. Besides, the experts tell you stocks always go higher after a fall. Of course, you would not be silly enough to buy HIH, One.Tel or Harris Scarfe.
5. Look to Trading to Provide the Action you Crave
The trouble with most jobs and occupations is that they are boring. Bosses and clients keep wanting to impose discipline on you. But discipline breeds mediocrity. To succeed, you only need get free of all those irksome restrictions. Who needs plans? Who needs to study and learn dreary details? Who needs to have to keep good records – make money and it looks after itself. No, the market is a way to get free of all the things that have always held you back. Go for it and the devil take the hindmost.
So, there you have it – five sure-fire ways to lose lots of money in the stock market.
http://www.bwts.com.au/download/redir/015-229cbe1fa45d50d9186c7357e9edddc4.pdf
The ways successful traders and investors think
The Twelve Commandments
I found that they are of general application to either trading or investing. Here are my renditions of his commandments:
1. It is important to be diversified as a trader or an investor. Never put more than 10% of your funds into one stock and no more that 20% into the one industry sector.
2. Regularly check how your investments are performing. Look at each one separately, ignoring the overall results for the last period. Be ruthless rather than hopeful.
3. Keep at least 50% of your funds in stocks that pay dividends.
4. Dividend yield is much less important that capital gain for investors as well as traders.
5. Close out losing trades and investments quickly. Be very reluctant to realise profits.
6. Never exceed 25% of you funds in speculative stocks, illiquid stocks or a stock about which information is not published regularly.
7. Never, ever invest on the basis of “inside information”. You can be sure you are the last to hear it.
8. Never ask advice about what stocks to buy or sell. Do your own work, based on facts, not the opinions of others.
9. Mechanical formulas and methods for trading, investing or analysing investments should be avoided. Thinking is hard work, but these things make you intellectually lazy.
10. In boom conditions, half your funds should be moved into short-term bonds.
11. Never borrow heavily to invest and only when stocks are depressed.
12. Consider putting a small proportion of your funds into long-term options (if available) in promising companies.
Finally, a direct quotation from Phil Carret’s The Art of Speculation, which contains one of the most important of the ways successful traders and investors think that is the exact opposite to the way losing traders and investors look at the problem:
If (the speculator) has 100 shares of a given stock, for example, which is selling at 90, he should disregard entirely the price that he paid for it and ask himself this question: “If I had $9,000 cash today and wished to purchase some security, would I choose that stock in preference to every one of the thousands of other securities available to me?” If the answer is strongly negative, he should sell the stock. It should not make the slightest difference in this connection whether the stock cost 50 or 130. That is a fact which is entirely beside the point, though the average individual will give it considerable weight.
http://www.bwts.com.au/download/redir/015-229cbe1fa45d50d9186c7357e9edddc4.pdf
I found that they are of general application to either trading or investing. Here are my renditions of his commandments:
1. It is important to be diversified as a trader or an investor. Never put more than 10% of your funds into one stock and no more that 20% into the one industry sector.
2. Regularly check how your investments are performing. Look at each one separately, ignoring the overall results for the last period. Be ruthless rather than hopeful.
3. Keep at least 50% of your funds in stocks that pay dividends.
4. Dividend yield is much less important that capital gain for investors as well as traders.
5. Close out losing trades and investments quickly. Be very reluctant to realise profits.
6. Never exceed 25% of you funds in speculative stocks, illiquid stocks or a stock about which information is not published regularly.
7. Never, ever invest on the basis of “inside information”. You can be sure you are the last to hear it.
8. Never ask advice about what stocks to buy or sell. Do your own work, based on facts, not the opinions of others.
9. Mechanical formulas and methods for trading, investing or analysing investments should be avoided. Thinking is hard work, but these things make you intellectually lazy.
10. In boom conditions, half your funds should be moved into short-term bonds.
11. Never borrow heavily to invest and only when stocks are depressed.
12. Consider putting a small proportion of your funds into long-term options (if available) in promising companies.
Finally, a direct quotation from Phil Carret’s The Art of Speculation, which contains one of the most important of the ways successful traders and investors think that is the exact opposite to the way losing traders and investors look at the problem:
If (the speculator) has 100 shares of a given stock, for example, which is selling at 90, he should disregard entirely the price that he paid for it and ask himself this question: “If I had $9,000 cash today and wished to purchase some security, would I choose that stock in preference to every one of the thousands of other securities available to me?” If the answer is strongly negative, he should sell the stock. It should not make the slightest difference in this connection whether the stock cost 50 or 130. That is a fact which is entirely beside the point, though the average individual will give it considerable weight.
http://www.bwts.com.au/download/redir/015-229cbe1fa45d50d9186c7357e9edddc4.pdf
Why do people hold on to losing stocks?
Revisiting a behavioral economics classic: Why do people hold on to losing stocks?
By nudgeblog
Tyler Cowen poses the following question about stocks, and what he says used to be the conventional behavioral economics answer.
Let’s say you bought two stocks last year. One has tanked and looks likely to fall further. One has gone up and you expect it to keep rising. (Hey, it’s not completely impossible.) Which are you more apt to sell?
Behavioral economists used to think they knew the answer: neither. Studies have shown that people tend to value things more – whether shirts, stereos or stocks – once they own them, no matter what has happened to their actual worth. This phenomenon is called the endowment effect. If it were the only psychological factor at work, you’d be reluctant to sell both losers and winners simply because they’re already tucked into your portfolio.
Cowen’s story is incomplete, and therefore unfair, even to old behavioral economists. In the scenario Cowen describes, two biases, each reinforcing the other, would be in effect: The endowment effect and loss aversion. The endowment effects for both stocks (assuming you bought them at the same price) would cancel each other out, but this would not necessarily mean investor paralysis. For more than twenty years, behavioral economists have been citing something called the disposition effect, which is an implication of prospect theory and the component of loss aversion). The status quo purchase price serves a reference point. Gains and losses are perceived relative to some other aspirational level different from the status quo – say, what you thought the stock would rise to. As the winner is closer to this aspiration, you, as the investor, become more risk-averse and therefore more likely to sell it, while holding on to the loser in the hopes of a roaring comeback, even one with a small probability.
But this isn’t the only explanation for identical behavior. An alternative is a commonly mistaken belief among average investors that stocks will revert to their mean. Stocks that have risen will fall; stocks that have fallen will rise. This story also predicts the selling of winners on the expectation that it will fall. Yes, Cowen’s scenarios says you, the ordinary investor, would expect the winning stock to keep rising. Old behavioral economics says you’d be quite extraordinary for believing this. Both of these potential explanations are laid out in Terrance Odean’s classic paper “Are Investors Reluctant to Realize Their Losses?” His data does allow him to distinguish which of the two stories makes more sense.
Addendum: Cowen’s column is actually an appreciation of a paper by Nicholas C. Barberis and Wei Xiong with yet another explanation for why investors sell winners and hold onto losers: That it’s the pleasure of actual (or what stock traders would called realized) gains – the good feeling you get from making a seemingly smart decision – and the pain of actual losses that leads to selling winners. Read the full paper.
http://nudges.wordpress.com/2009/01/29/revisiting-a-behavioral-economics-classic-why-do-people-hold-on-to-losing-stocks/
By nudgeblog
Tyler Cowen poses the following question about stocks, and what he says used to be the conventional behavioral economics answer.
Let’s say you bought two stocks last year. One has tanked and looks likely to fall further. One has gone up and you expect it to keep rising. (Hey, it’s not completely impossible.) Which are you more apt to sell?
Behavioral economists used to think they knew the answer: neither. Studies have shown that people tend to value things more – whether shirts, stereos or stocks – once they own them, no matter what has happened to their actual worth. This phenomenon is called the endowment effect. If it were the only psychological factor at work, you’d be reluctant to sell both losers and winners simply because they’re already tucked into your portfolio.
Cowen’s story is incomplete, and therefore unfair, even to old behavioral economists. In the scenario Cowen describes, two biases, each reinforcing the other, would be in effect: The endowment effect and loss aversion. The endowment effects for both stocks (assuming you bought them at the same price) would cancel each other out, but this would not necessarily mean investor paralysis. For more than twenty years, behavioral economists have been citing something called the disposition effect, which is an implication of prospect theory and the component of loss aversion). The status quo purchase price serves a reference point. Gains and losses are perceived relative to some other aspirational level different from the status quo – say, what you thought the stock would rise to. As the winner is closer to this aspiration, you, as the investor, become more risk-averse and therefore more likely to sell it, while holding on to the loser in the hopes of a roaring comeback, even one with a small probability.
But this isn’t the only explanation for identical behavior. An alternative is a commonly mistaken belief among average investors that stocks will revert to their mean. Stocks that have risen will fall; stocks that have fallen will rise. This story also predicts the selling of winners on the expectation that it will fall. Yes, Cowen’s scenarios says you, the ordinary investor, would expect the winning stock to keep rising. Old behavioral economics says you’d be quite extraordinary for believing this. Both of these potential explanations are laid out in Terrance Odean’s classic paper “Are Investors Reluctant to Realize Their Losses?” His data does allow him to distinguish which of the two stories makes more sense.
Addendum: Cowen’s column is actually an appreciation of a paper by Nicholas C. Barberis and Wei Xiong with yet another explanation for why investors sell winners and hold onto losers: That it’s the pleasure of actual (or what stock traders would called realized) gains – the good feeling you get from making a seemingly smart decision – and the pain of actual losses that leads to selling winners. Read the full paper.
http://nudges.wordpress.com/2009/01/29/revisiting-a-behavioral-economics-classic-why-do-people-hold-on-to-losing-stocks/
When to Sell Your Stock for the traders
Jul 15 2005
A Discussion Of The Most Difficult Part of Trading - When to Sell Your Stock
Posted By Tate Dwinnell
Question:
I am struggling a bit with my profit taking sell rules. I do pretty
well selling positions that aren’t working to keep my losses small.
However, I have trouble holding on to my winners. I either sell too
early wanting to bank that profit (especially after a few losses in a
row) or watch a winner turn into a breakeven or small loser (I try to
limit my winners from becoming big losers). I am trying to do the
O’Neil 3 to 1 thing but find many of my purchases never quite make it to
the ~20% level before they correct.
Do you have specific sell rules?
Any ideas in this area would be much appreciated.
My Response:
It’s a good question - selling to take a profit is the most difficult part
of investing because there are so many if’s, and or buts.
Honestly, I don’t have specific sell rules but do follow certain guidelines
you’ll want to consider:
1. I almost always sell before an earnings announcement
2. Typically, you’ll want to lock in profits around 20 - 25% in a strong
market, but towards the end of a bull run or in an iffy market, consider
taking profits at 15%. So instead of a (20% - 25% to 7%-8% ratio) use a
(15% to 5% ratio). If you look at my model portfolio, you’ll notice that
the average gain is around 15.5% and the average loss around 5.5%. Maybe
consider taking profits at 15% while keeping losses small. You can be right
less than half the time and still do very well.
3. Did the the stock break out with force and run up quickly then
consolidate quietly? Is it still exhibiting good price and volume action
(heavy buying, light volume selling). If so, this could be a big winner for
you and you may want to hold out for profits more than 20 - 25% in a
strong bull market.
4. Look for a change in trend of price and volume as a signal to lock in
gains. A good example is CBG, a current Model P. holding. Beginning July
5th, buy volume began to subside as it edged higher. Of course in hindsight
I should have locked in that 20% profit right then and there. At the time I
was thinking that post holiday trade was skewing the volume a bit and high
volume selling hadn’t yet appeared. Now that they have appeared I am
looking for an exit point, preferably around 45, if it can get that far. I
still have a decent chance of locking in 15% profits before earnings.
5. Don’t forget to pay attention to upward trend lines as well as prior
resistance points as well. They can provide good predeterminded sell
points. A good example of this is DCAI, another current holding in the M.P.
This is a stock that has carved out a deep base, with resistance at the high
in the left side around 35. Would I continue holding if it hits that high?
No, I’m taking very nice profits off the table. Deep bases have a much
higher failure rate, so it’s unlikely that DCAI gets to 35, carves a nice
handle and shoots to the moon. I’m just looking for a nice run in the right
side and unloading.
Selling is somewhat of an art form and you will never be perfect. If you
can keep losses small and maybe move your profit target closer in a bit, you
will be successful.
I have certainly had my share of blunders. In 2003, I took a quick 50% gain
in TASR, that cost me 10’s of thousands in the long run. At the beginning
of this year, I let large gains in DHB, XXIA and TASR slip away in the Model
Portfolio and have been chipping away all year to recover those losses. It
is important to track your trades and learn from mistakes. Be flexible and
adjust.
I think you’re on the right track, just a few minor adjustments.
Member Response:
Thanks. I agree selling is the most difficult but probably the most
important as well. I have tried to adhere to the 3 to 1 mantra but most
of my stocks purchased have corrected before they hit the 20% range and
then I hold on too long for either a small loss or gain. I have more
recently been willing to take 12 - 15% gains but then feel my stops
become a little too tight and get stopped out of good trades.
I have since widen my stops a bit but try to keep losses to 4 - 5% and
then take 10 - 15% gains, especially in a less than raging bull.
Do you see value in a 1st level profit target where you would sell 75%
of your position and a 2nd profit target to sell the remaining 25%? I
have always talked myself out of this type of selling but know
evaluating the merits again. What are your thoughts?
My Response:
If you’re buying at the correct time, cutting your losses at 5% should keep
you in the majority of trades, provided you have good entry points. Maybe
take a look at your entry points and the quality of the base? I’d be happy
to take a look at a few if you’d like.
I do see some value in taking partial profits depending on the situation,
but I’m more of an all or nothing trader. This keeps the number of
positions to a minimum and keeps commission costs lower. It really depends
on the company. I think that the solid, established companies like an
Apple, Starbux, Google ,etc this method can be a good one for locking in
profits ahead of earnings. For example, I will most likely take 50% profit
on Google before earnings are released (on the 21st) and let the other half
ride. If the stock drops to support maybe I add back that other half. If
the stock soars on the earnings, you still gain on the other half. However,
with more volatile, unestablished companies, the best option is to usually
sell ALL before an earnings report.
Generally speaking, I think it’s best to avoid getting too cute with
selling. If you have the solid 20% gain, take it… ALL of it. Just
remember the signs of what to look for with the potential big winners, which
might provide larger gains.
http://selfinvestors.com/tradingstocks/mail-bag/the-most-difficult-part-of-trading-when-to-sell-your-stock/
A Discussion Of The Most Difficult Part of Trading - When to Sell Your Stock
Posted By Tate Dwinnell
Question:
I am struggling a bit with my profit taking sell rules. I do pretty
well selling positions that aren’t working to keep my losses small.
However, I have trouble holding on to my winners. I either sell too
early wanting to bank that profit (especially after a few losses in a
row) or watch a winner turn into a breakeven or small loser (I try to
limit my winners from becoming big losers). I am trying to do the
O’Neil 3 to 1 thing but find many of my purchases never quite make it to
the ~20% level before they correct.
Do you have specific sell rules?
Any ideas in this area would be much appreciated.
My Response:
It’s a good question - selling to take a profit is the most difficult part
of investing because there are so many if’s, and or buts.
Honestly, I don’t have specific sell rules but do follow certain guidelines
you’ll want to consider:
1. I almost always sell before an earnings announcement
2. Typically, you’ll want to lock in profits around 20 - 25% in a strong
market, but towards the end of a bull run or in an iffy market, consider
taking profits at 15%. So instead of a (20% - 25% to 7%-8% ratio) use a
(15% to 5% ratio). If you look at my model portfolio, you’ll notice that
the average gain is around 15.5% and the average loss around 5.5%. Maybe
consider taking profits at 15% while keeping losses small. You can be right
less than half the time and still do very well.
3. Did the the stock break out with force and run up quickly then
consolidate quietly? Is it still exhibiting good price and volume action
(heavy buying, light volume selling). If so, this could be a big winner for
you and you may want to hold out for profits more than 20 - 25% in a
strong bull market.
4. Look for a change in trend of price and volume as a signal to lock in
gains. A good example is CBG, a current Model P. holding. Beginning July
5th, buy volume began to subside as it edged higher. Of course in hindsight
I should have locked in that 20% profit right then and there. At the time I
was thinking that post holiday trade was skewing the volume a bit and high
volume selling hadn’t yet appeared. Now that they have appeared I am
looking for an exit point, preferably around 45, if it can get that far. I
still have a decent chance of locking in 15% profits before earnings.
5. Don’t forget to pay attention to upward trend lines as well as prior
resistance points as well. They can provide good predeterminded sell
points. A good example of this is DCAI, another current holding in the M.P.
This is a stock that has carved out a deep base, with resistance at the high
in the left side around 35. Would I continue holding if it hits that high?
No, I’m taking very nice profits off the table. Deep bases have a much
higher failure rate, so it’s unlikely that DCAI gets to 35, carves a nice
handle and shoots to the moon. I’m just looking for a nice run in the right
side and unloading.
Selling is somewhat of an art form and you will never be perfect. If you
can keep losses small and maybe move your profit target closer in a bit, you
will be successful.
I have certainly had my share of blunders. In 2003, I took a quick 50% gain
in TASR, that cost me 10’s of thousands in the long run. At the beginning
of this year, I let large gains in DHB, XXIA and TASR slip away in the Model
Portfolio and have been chipping away all year to recover those losses. It
is important to track your trades and learn from mistakes. Be flexible and
adjust.
I think you’re on the right track, just a few minor adjustments.
Member Response:
Thanks. I agree selling is the most difficult but probably the most
important as well. I have tried to adhere to the 3 to 1 mantra but most
of my stocks purchased have corrected before they hit the 20% range and
then I hold on too long for either a small loss or gain. I have more
recently been willing to take 12 - 15% gains but then feel my stops
become a little too tight and get stopped out of good trades.
I have since widen my stops a bit but try to keep losses to 4 - 5% and
then take 10 - 15% gains, especially in a less than raging bull.
Do you see value in a 1st level profit target where you would sell 75%
of your position and a 2nd profit target to sell the remaining 25%? I
have always talked myself out of this type of selling but know
evaluating the merits again. What are your thoughts?
My Response:
If you’re buying at the correct time, cutting your losses at 5% should keep
you in the majority of trades, provided you have good entry points. Maybe
take a look at your entry points and the quality of the base? I’d be happy
to take a look at a few if you’d like.
I do see some value in taking partial profits depending on the situation,
but I’m more of an all or nothing trader. This keeps the number of
positions to a minimum and keeps commission costs lower. It really depends
on the company. I think that the solid, established companies like an
Apple, Starbux, Google ,etc this method can be a good one for locking in
profits ahead of earnings. For example, I will most likely take 50% profit
on Google before earnings are released (on the 21st) and let the other half
ride. If the stock drops to support maybe I add back that other half. If
the stock soars on the earnings, you still gain on the other half. However,
with more volatile, unestablished companies, the best option is to usually
sell ALL before an earnings report.
Generally speaking, I think it’s best to avoid getting too cute with
selling. If you have the solid 20% gain, take it… ALL of it. Just
remember the signs of what to look for with the potential big winners, which
might provide larger gains.
http://selfinvestors.com/tradingstocks/mail-bag/the-most-difficult-part-of-trading-when-to-sell-your-stock/
Tips On How To Maximize Stock Profits
Tips On How To Maximize Stock Profits
By Mark Crisp
When the stock market marches into record territory like it has been, it's tempting to take some shares off the table. The prudent investor, it's been said, will sell his losers and keep his winners. To maximize stock profits, the goal is to keep profits from the winners. Holding onto losing positions, or worse, adding to them, can put a dent in those profits.
Some stocks will buck the trends of their sector or the general market. If there are no buyers for a stock it is probably a good idea to get out of that stock and put your money somewhere else. This means that you need to keep winners, and cut laggards and losing stocks.
Knowing when to buy and sell is probably the most challenging aspect of investing. It's been said that timing is everything, and that's certainly true for small investors who want to maximize stock profits. While there are many systems and methods dedicated to market timing, certain observations can help one make an informed decision.
Investors seek every clue and advantage to know when it is best to buy or sell, and many canny stock traders watch volume. Volume is a simple matter of the total shares traded during a single market day. Modern technology tracks trading volume minute by minute in real time and some use this routinely. An investor can seize an opportunity by using signals like volume because they telegraph changes, and increasing volume is linked to price volatility and the greater the volume, the more likely the prices will also be extremely increased or decreased.
Scaling in and out of positions is an additional way to maximize stock profits. Rather than completely buying in or selling out of a position it is conventionally considered prudent to purchase part of a position as a stock rises, and selling part of it when getting out. In this process the investor knows that they are buying a winner heading up, while not being overly greedy by holding their position for too long when selling time has come.
In today's bull market, there are plenty of high performing stocks to chose from, and getting in at the right time can mean difference between making a little and making a lot.
Maximize stock profits by selling loser stocks and keeping winners. Gut laggards that fail to grow in the sector or the whole market. Timing is everything. Watch for certain key signs when investing, like watch volume. Increasing volume usually mirrors increasing volatility in price. Huge volume days can signal a near term high or low in price. Carefully watch volume signals and daily trading activity to make the best profit possible. Another way to maximize stock profits is by scaling in and out of positions. Buy a winning stock on the way up but do not be too greedy and hold the stock too long.
Article Source: http://EzineArticles.com/?expert=Mark_Crisp
http://ezinearticles.com/?Tips-On-How-To-Maximize-Stock-Profits&id=821183
By Mark Crisp
When the stock market marches into record territory like it has been, it's tempting to take some shares off the table. The prudent investor, it's been said, will sell his losers and keep his winners. To maximize stock profits, the goal is to keep profits from the winners. Holding onto losing positions, or worse, adding to them, can put a dent in those profits.
Some stocks will buck the trends of their sector or the general market. If there are no buyers for a stock it is probably a good idea to get out of that stock and put your money somewhere else. This means that you need to keep winners, and cut laggards and losing stocks.
Knowing when to buy and sell is probably the most challenging aspect of investing. It's been said that timing is everything, and that's certainly true for small investors who want to maximize stock profits. While there are many systems and methods dedicated to market timing, certain observations can help one make an informed decision.
Investors seek every clue and advantage to know when it is best to buy or sell, and many canny stock traders watch volume. Volume is a simple matter of the total shares traded during a single market day. Modern technology tracks trading volume minute by minute in real time and some use this routinely. An investor can seize an opportunity by using signals like volume because they telegraph changes, and increasing volume is linked to price volatility and the greater the volume, the more likely the prices will also be extremely increased or decreased.
Scaling in and out of positions is an additional way to maximize stock profits. Rather than completely buying in or selling out of a position it is conventionally considered prudent to purchase part of a position as a stock rises, and selling part of it when getting out. In this process the investor knows that they are buying a winner heading up, while not being overly greedy by holding their position for too long when selling time has come.
In today's bull market, there are plenty of high performing stocks to chose from, and getting in at the right time can mean difference between making a little and making a lot.
Maximize stock profits by selling loser stocks and keeping winners. Gut laggards that fail to grow in the sector or the whole market. Timing is everything. Watch for certain key signs when investing, like watch volume. Increasing volume usually mirrors increasing volatility in price. Huge volume days can signal a near term high or low in price. Carefully watch volume signals and daily trading activity to make the best profit possible. Another way to maximize stock profits is by scaling in and out of positions. Buy a winning stock on the way up but do not be too greedy and hold the stock too long.
Article Source: http://EzineArticles.com/?expert=Mark_Crisp
http://ezinearticles.com/?Tips-On-How-To-Maximize-Stock-Profits&id=821183
Avoiding The Avoiding Of Regret
Avoiding The Avoiding Of Regret
Avoiding the emotional pain of regret causes you to sell winners too soon and hold on to losers too long. This causes a loss of wealth from taxes and a bias toward holding stocks that perform poorly.
How can you avoid this pitfall? The first step is to understand this psychological bias. This chapter should help you accomplish this step. Two other steps are helpful:
1. Make sell decisions before you are emotionally tied to the position.
2. Keep a reminder of the avoiding regret problem.
For example, when buying a stock for $100, you should decide at which price you will sell the stock if the price declines. You may decide to sell if the price falls to $90. However, making this decision before the price actually falls is not enough. You must act. You must act in advance, before the stock actually falls and regret starts to take place. How do you accomplish this? Place a stop-loss order. A stop-loss order is an order that tells the brokerage to sell the stock if it ever falls to a predetermined price. A stop-loss order at $90 will cause the stock to automatically be sold if the price falls to $90. This order is placed when the stock is still at $100 and regret has not had a chance to occur.
Another strategy is to make a point of selling enough losers to offset any gains that you might have incurred during the year. Although this can be done any time during the year, you probably feel most comfortable doing this in December. In fact, December is the most common month to take losses for tax purposes. Investors often use the end-of-the-year tax deadline as motivation to sell losers. However, losers can be sold at any time during the year to achieve the tax benefits. The reason that tax-loss selling usually occurs in December is that the closer you get to the end of the year, the tax-reduction motive has more influence over investors than the disposition effect.
Finally, keep a reminder of the avoiding regret problem. Consider how many futures traders train to do their jobs. Futures traders often take very risky short-term positions in the market. They can gain or lose large sums of money in minutes or even seconds. Some futures traders have told me that they memorized a saying:
You have to love to take losses and hate to take gains.
At first, this saying makes no sense. Why would you hate to take gains? The power of the saying is that it exactly counteracts the disposition effect. The avoidance of regret causes traders to want to hold on to losers too long. "You have to love to take losses" reminds them to sell quickly and get out of a bad position when the market has moved against them. Alternatively, the seeking of pride causes traders to sell their winners too soon. "Hate to take gains" reminds them to not be so quick to take a profit. Hold the winning positions longer than your natural desire for pride would suggest.
IN SUMMARY
To summarize this chapter, you act (or fail to act) to seek pride and avoid regret. This behavior causes you to sell your winners too soon and hold your losers too long. This behavior hurts your wealth in two ways. First, you pay more capital gains taxes because you sell winners. Second, you earn a lower return because the winners you sell and no longer have continue to perform well while the losers you still hold continue to perform poorly.
Avoiding the emotional pain of regret causes you to sell winners too soon and hold on to losers too long. This causes a loss of wealth from taxes and a bias toward holding stocks that perform poorly.
How can you avoid this pitfall? The first step is to understand this psychological bias. This chapter should help you accomplish this step. Two other steps are helpful:
1. Make sell decisions before you are emotionally tied to the position.
2. Keep a reminder of the avoiding regret problem.
For example, when buying a stock for $100, you should decide at which price you will sell the stock if the price declines. You may decide to sell if the price falls to $90. However, making this decision before the price actually falls is not enough. You must act. You must act in advance, before the stock actually falls and regret starts to take place. How do you accomplish this? Place a stop-loss order. A stop-loss order is an order that tells the brokerage to sell the stock if it ever falls to a predetermined price. A stop-loss order at $90 will cause the stock to automatically be sold if the price falls to $90. This order is placed when the stock is still at $100 and regret has not had a chance to occur.
Another strategy is to make a point of selling enough losers to offset any gains that you might have incurred during the year. Although this can be done any time during the year, you probably feel most comfortable doing this in December. In fact, December is the most common month to take losses for tax purposes. Investors often use the end-of-the-year tax deadline as motivation to sell losers. However, losers can be sold at any time during the year to achieve the tax benefits. The reason that tax-loss selling usually occurs in December is that the closer you get to the end of the year, the tax-reduction motive has more influence over investors than the disposition effect.
Finally, keep a reminder of the avoiding regret problem. Consider how many futures traders train to do their jobs. Futures traders often take very risky short-term positions in the market. They can gain or lose large sums of money in minutes or even seconds. Some futures traders have told me that they memorized a saying:
You have to love to take losses and hate to take gains.
At first, this saying makes no sense. Why would you hate to take gains? The power of the saying is that it exactly counteracts the disposition effect. The avoidance of regret causes traders to want to hold on to losers too long. "You have to love to take losses" reminds them to sell quickly and get out of a bad position when the market has moved against them. Alternatively, the seeking of pride causes traders to sell their winners too soon. "Hate to take gains" reminds them to not be so quick to take a profit. Hold the winning positions longer than your natural desire for pride would suggest.
IN SUMMARY
To summarize this chapter, you act (or fail to act) to seek pride and avoid regret. This behavior causes you to sell your winners too soon and hold your losers too long. This behavior hurts your wealth in two ways. First, you pay more capital gains taxes because you sell winners. Second, you earn a lower return because the winners you sell and no longer have continue to perform well while the losers you still hold continue to perform poorly.
Wednesday 2 September 2009
Winning the Loser’s Game
Winning the Loser’s Game
By Daily Reckoning Contributor
07/14/05
Investing is a loser’s game - good investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They play it safe, avoid errors in judgment - and stick to the basics.
My stepdaughter Rachel is 11 years old.
I’ve been watching her play softball every summer since she was eight. Each game is both tragic and comic…
When the ball is hit in the air, you can bet it’ll hit the ground, occasionally taking a split-second detour into some hopeful little girl’s glove. When the ball is hit on the ground, it is generally hit with pinpoint accuracy, as it nearly always goes right through the legs of the fielder closest to it.
Runs are scored in Rachel’s softball games when somebody drops the ball. There are no homeruns hit over the fence. Many runs are the result of four walks in a row. There are few successful defensive plays of any kind. Balls are thrown but rarely caught. Bases are stolen routinely because the girls are trained to hold onto the ball lest they throw it away, allowing a second base to be stolen.
Loser’s Game: Beating Yourself vs. Beating the Competition
Rachel’s games are nothing like major league baseball games. In the major leagues, home runs are hit out of the park and double plays are thrown in most games. Strikeouts don’t happen because the batting is bad, but because the pitching is so amazingly good. It’s just like in the Ellis book, Winning the Loser’s Game. The little leaguers don’t get beat by the competition; they beat themselves by making errors. The professional ballplayers don’t beat themselves; they are simply outperformed by the competition.
Ellis reports on Dr. Simon Ramo. In his book, Extraordinary Tennis for the Ordinary Tennis Player, Ramo found that, "professional tennis is a winner’s game: The outcome is determined by the actions of the winner. Amateur tennis is a loser’s game: the outcome is determined by the actions of the loser, who defeats himself." War is another loser’s game. According to historian Admiral Samuel Eliot Morison, "the side that makes the fewest strategic errors wins the war." Tommy Armour’s book, How to Play Your Best Golf All the Time, says, "the best way to win is by making fewer bad shots."
Investing is a loser’s game. And it never becomes a winner’s game. It’s like my stepdaughter’s softball league. All you have to do is not make huge mistakes. You never focus on beating a competitor. The greatest investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They mostly just play it safe and avoid big errors. Warren Buffett’s quote on this matter can’t be repeated often enough:
Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.
Loser’s Game: It’s All About the Basics
I’m beginning to believe that investing is mostly about ruthlessly following basic precepts like, "Never lose money." You never really graduate to the advanced class, because there isn’t one. You simply realize that it’s all about the basics, and then you stop losing money… and start getting rich. Like most of the traits that make a successful investor, this one goes against human nature. We humans love to complicate things. But with investing, the simple answer is the one towards which you should gravitate. As Ben Graham writes on page 147 of The Intelligent Investor, "security analysts today find themselves compelled to become most mathematical and ’scientific’ in the very situations which lend themselves least auspiciously to exact treatment."
Not only do we humans want to complicate things. We also have a bias toward action. This is simply the tendency to want to "do something" and not remain passive. It’s even worse that this bias serves you well in virtually any other business but investing. Tom Peters listed "a bias toward action" as the number one trait of effective managers in his classic work, In Search of Excellence.
Warren Buffett once said something like, "Lethargy bordering on sloth strikes us as intelligent behavior." If I were to recommend more than five or six stocks a year in these pages, maybe you should question the quality of those ideas.
Unlikely as it may sound, I think that if you do nothing but decide right here and now that you’ll make fewer investment decisions and avoid bad ideas, your performance will improve dramatically. This is something you hardly ever read about in newsletters, because newsletter editors have a bias toward feeding the typical reader’s desire for new stock picks. Editors aren’t bad people. It’s just that most readers think they’re paying for the production of a certain number of ideas. Most editors lose subscribers if they don’t recommend a brand new stock every month.
How many stocks should you own at one time? Any amount you want, as long as it’s not too many.
In October 1994, Warren Buffett addressed a room full of graduate students at Kenan Flagler business school in North Carolina. He told them, "I made a study back when I ran a partnership of all our larger investments versus all our smaller investments. The larger investments always did better than the smaller investments. There’s a threshold of examination and criticism and knowledge that has to be overcome or reached in making a big decision. You can get sloppy about small decisions. You’ve all heard about somebody who says, ‘I bought 100 shares of this or that because I heard about it at a party the other night.’ There is that tendency with small decisions to think you can do it for not very good reasons. I think larger decisions are helpful in that regard." During the same talk, Buffett said, "If you have 10 great ideas in your life, you can afford to give away 5 of them, because that’s all you’ll need."
If you simply decide to make fewer investment decisions, you’ll naturally take greater pains to make better decisions. Says Buffett, "Your default position should always be short-term instruments. And whenever you see anything intelligent to do, you should do it." Buffett also said that asset allocation, a Wall Street obsession, is pure nonsense. Asset allocation is Wall Street B.S. for when Abby Jo Cohen announces, in a very pompous way, that now she’s going to recommend that you put 65% of your money in stocks, and 35% in bonds, when before it was 60% in stocks and 40% in bonds. People actually pay a lot of money for that kind of advice. Educated people. People who would otherwise impress us with their connections and money and power.
Jim Rogers is somebody else you ought to listen to on the subject of managing your own money. He used to work with the famous billionaire trader George Soros. Rogers drove around the world twice, once on a motorcycle and once in a car, and wrote a book about global investing after each trip. Rogers told author John Train in 1989 that you should, "take your money, put it in Treasury bills or a money-market fund. Just sit back, go to the beach, go to the movies, play checkers, do whatever you want to. Then something will come along where you know it’s right. Take all your money out of the money-market fund, put it in whatever it happens to be, and stay with it for three or four or five or ten years, whatever it is. You’ll know when to sell again, because you’ll know more about it than anybody else. Take your money out, put it back in the money-market fund, and wait for the next thing to come along. When it does, you’ll make a whole lot of money."
Of course, a tangible margin of safety isn’t always necessary, but it’s hard to argue with. Making a mistake doesn’t mean the principles are wrong. It means I need to work harder to get them right. I’d encourage you to do the same.
Regards,
Dan Ferris
for The Daily Reckoning
http://dailyreckoning.com/winning-the-losers-game/
By Daily Reckoning Contributor
07/14/05
Investing is a loser’s game - good investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They play it safe, avoid errors in judgment - and stick to the basics.
My stepdaughter Rachel is 11 years old.
I’ve been watching her play softball every summer since she was eight. Each game is both tragic and comic…
When the ball is hit in the air, you can bet it’ll hit the ground, occasionally taking a split-second detour into some hopeful little girl’s glove. When the ball is hit on the ground, it is generally hit with pinpoint accuracy, as it nearly always goes right through the legs of the fielder closest to it.
Runs are scored in Rachel’s softball games when somebody drops the ball. There are no homeruns hit over the fence. Many runs are the result of four walks in a row. There are few successful defensive plays of any kind. Balls are thrown but rarely caught. Bases are stolen routinely because the girls are trained to hold onto the ball lest they throw it away, allowing a second base to be stolen.
Loser’s Game: Beating Yourself vs. Beating the Competition
Rachel’s games are nothing like major league baseball games. In the major leagues, home runs are hit out of the park and double plays are thrown in most games. Strikeouts don’t happen because the batting is bad, but because the pitching is so amazingly good. It’s just like in the Ellis book, Winning the Loser’s Game. The little leaguers don’t get beat by the competition; they beat themselves by making errors. The professional ballplayers don’t beat themselves; they are simply outperformed by the competition.
Ellis reports on Dr. Simon Ramo. In his book, Extraordinary Tennis for the Ordinary Tennis Player, Ramo found that, "professional tennis is a winner’s game: The outcome is determined by the actions of the winner. Amateur tennis is a loser’s game: the outcome is determined by the actions of the loser, who defeats himself." War is another loser’s game. According to historian Admiral Samuel Eliot Morison, "the side that makes the fewest strategic errors wins the war." Tommy Armour’s book, How to Play Your Best Golf All the Time, says, "the best way to win is by making fewer bad shots."
Investing is a loser’s game. And it never becomes a winner’s game. It’s like my stepdaughter’s softball league. All you have to do is not make huge mistakes. You never focus on beating a competitor. The greatest investors do not pull financial rabbits out of their hats or solve difficult scientific problems. They mostly just play it safe and avoid big errors. Warren Buffett’s quote on this matter can’t be repeated often enough:
Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1.
Loser’s Game: It’s All About the Basics
I’m beginning to believe that investing is mostly about ruthlessly following basic precepts like, "Never lose money." You never really graduate to the advanced class, because there isn’t one. You simply realize that it’s all about the basics, and then you stop losing money… and start getting rich. Like most of the traits that make a successful investor, this one goes against human nature. We humans love to complicate things. But with investing, the simple answer is the one towards which you should gravitate. As Ben Graham writes on page 147 of The Intelligent Investor, "security analysts today find themselves compelled to become most mathematical and ’scientific’ in the very situations which lend themselves least auspiciously to exact treatment."
Not only do we humans want to complicate things. We also have a bias toward action. This is simply the tendency to want to "do something" and not remain passive. It’s even worse that this bias serves you well in virtually any other business but investing. Tom Peters listed "a bias toward action" as the number one trait of effective managers in his classic work, In Search of Excellence.
Warren Buffett once said something like, "Lethargy bordering on sloth strikes us as intelligent behavior." If I were to recommend more than five or six stocks a year in these pages, maybe you should question the quality of those ideas.
Unlikely as it may sound, I think that if you do nothing but decide right here and now that you’ll make fewer investment decisions and avoid bad ideas, your performance will improve dramatically. This is something you hardly ever read about in newsletters, because newsletter editors have a bias toward feeding the typical reader’s desire for new stock picks. Editors aren’t bad people. It’s just that most readers think they’re paying for the production of a certain number of ideas. Most editors lose subscribers if they don’t recommend a brand new stock every month.
How many stocks should you own at one time? Any amount you want, as long as it’s not too many.
In October 1994, Warren Buffett addressed a room full of graduate students at Kenan Flagler business school in North Carolina. He told them, "I made a study back when I ran a partnership of all our larger investments versus all our smaller investments. The larger investments always did better than the smaller investments. There’s a threshold of examination and criticism and knowledge that has to be overcome or reached in making a big decision. You can get sloppy about small decisions. You’ve all heard about somebody who says, ‘I bought 100 shares of this or that because I heard about it at a party the other night.’ There is that tendency with small decisions to think you can do it for not very good reasons. I think larger decisions are helpful in that regard." During the same talk, Buffett said, "If you have 10 great ideas in your life, you can afford to give away 5 of them, because that’s all you’ll need."
If you simply decide to make fewer investment decisions, you’ll naturally take greater pains to make better decisions. Says Buffett, "Your default position should always be short-term instruments. And whenever you see anything intelligent to do, you should do it." Buffett also said that asset allocation, a Wall Street obsession, is pure nonsense. Asset allocation is Wall Street B.S. for when Abby Jo Cohen announces, in a very pompous way, that now she’s going to recommend that you put 65% of your money in stocks, and 35% in bonds, when before it was 60% in stocks and 40% in bonds. People actually pay a lot of money for that kind of advice. Educated people. People who would otherwise impress us with their connections and money and power.
Jim Rogers is somebody else you ought to listen to on the subject of managing your own money. He used to work with the famous billionaire trader George Soros. Rogers drove around the world twice, once on a motorcycle and once in a car, and wrote a book about global investing after each trip. Rogers told author John Train in 1989 that you should, "take your money, put it in Treasury bills or a money-market fund. Just sit back, go to the beach, go to the movies, play checkers, do whatever you want to. Then something will come along where you know it’s right. Take all your money out of the money-market fund, put it in whatever it happens to be, and stay with it for three or four or five or ten years, whatever it is. You’ll know when to sell again, because you’ll know more about it than anybody else. Take your money out, put it back in the money-market fund, and wait for the next thing to come along. When it does, you’ll make a whole lot of money."
Of course, a tangible margin of safety isn’t always necessary, but it’s hard to argue with. Making a mistake doesn’t mean the principles are wrong. It means I need to work harder to get them right. I’d encourage you to do the same.
Regards,
Dan Ferris
for The Daily Reckoning
http://dailyreckoning.com/winning-the-losers-game/
Ego investing
Ego investing
FE Investor Bureau
Posted online: Aug 03, 2009 at 0006 hrs
Gamblers and mathematicians maybe familiar with what is known as the Martingale probability theory or the Martingale betting strategy and the theory is simple and works on the assumption that a gambler with infinite wealth will never loose. This assumption leads many to take disproportionate risks.
All one needs to do is say in simple games of heads or tails or any other gamble, is to keep doubling his bet after every loss. This will ensure that as and when you do win a bet, you will not only recover all your losses but also make a profit of the original sum you invested. Say for example you bet Rs. 1,000 on heads and loose. Then you double your bet to Rs. 2,000 and loose again. Then you continue playing and double your bet to Rs. 4,000 and loose yet again. Now, you bet yet again, and this time you bet Rs. 8,000.
Having, this time finally won you get Rs. 8,000 and have hence, not only recovered the loss of Rs. 7,00 you had previously incurred, but also make a profit of Rs. 1,000 (the original sum bet).
No, this is not a fool proof or sure shot method to always making money in a casino nor is it a gambling tip. The interesting point to be noted for those who practice this theory is that one’s risk aversion pattern contradicts financial prudence and relies more on emotions.
It is for this reason itself that gamblers often keep on playing even after loosing all the money they decided they could afford to loose, simply in the hope of winning. The reason he/she does not get up and leave the casino is not because they cannot afford that loss sustained, but simply the fact that their ego has been bruised and hurt, and no one likes to end up losing. Hence, in the hope of turning things around one keeps at it till, more often then not they are completely wiped out.
This kind of emotional gambling or making of financial decisions is seen in two extremes, one is when you’re losing and one is when you’re winning heavily. If human financial stupidity were to be depicted in a bell curve, one would see it having a very heavy tail and a very small head. The tail represents the losers which are far greater in number than the winners, and, both have ended up there due to their irrational decisions. In investing they are often termed as greed and fear, with greed making most people follow the madness of the mob, in the hope of making some profits, while fear is what often causes people to try and convert a loss into a profit no matter how slim the odds, often ending up with a bigger loss than needed. "Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear" said William Gross, in his book, “Everything You've Heard About Investing is Wrong!”
Prospect theory
This is a theory that believes people value gains and losses differently and, as such, will base decisions on perceived gains rather than perceived losses. Hence, if a person were given two choices, one expressed in terms of possible gains and the other in possible losses, even though both amount to the same, people would choose the former. It is also known as "loss-aversion theory".
Tversky and Kahneman originally described, "Prospect Theory" in 1979. They found that contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains.
Some economists have concluded that investors typically consider the loss of Rs.1,000 twice as painful as the pleasure received from a gain of the same amount. They also found that individuals will respond differently to equivalent situations depending on whether it is presented in the context of losses or gains. Researchers have also found that people are willing to take more risks to avoid losses than to realize gains. Faced with sure gain, most investors are risk-averse, but faced with sure loss, investors become risk-takers.
--------------------------------------------------------------------------------
Here is an example from Tversky and Kahneman's 1979 article. Kahneman and Tversky presented groups of subjects with a number of problems. One group of subjects was presented with this problem:
In addition to whatever you own, you have been given $1,000. You are now asked to choose between:
a. A sure gain of $500
b. A 50% change to gain $1,000 and a 50% chance to gain nothing.
Another group of subjects was presented with another problem.
In addition to whatever you own, you have been given $2,000. You are now asked to choose between:
a. A sure loss of $500
b. A 50% chance to lose $1,000 and a 50% chance to lose nothing.
In the first group 84% chose A. In the second group 69% chose (b). The two problems are identical in terms of net cash to the subject, however the phrasing of the question causes the problems to be interpreted differently.
--------------------------------------------------------------------------------
Peter L Bernstein in “Against the Gods states that the evidence "reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty."
Prospect theory also explains why investors hold onto losing stocks: people often take more risks to avoid losses than to realize gains. For this reason, investors willingly remain in a risky stock position, hoping the price will bounce back. The loss-aversion theory points to another reason why investors might choose to hold their losers and sell their winners: they may believe that today's losers may soon outperform today's winners. Investors often make the mistake of chasing market action by investing in stocks or funds which garner the most attention. Research shows that money flows into high-performance mutual funds more rapidly than money flows out from funds that are underperforming.
Regret theory
People tend to feel sorrow and grief after having made an error in judgment. Investors deciding whether to sell a security are typically emotionally affected by whether the security was bought for more or less than the current price. One theory is that investors avoid selling stocks that have gone down in order to avoid the pain and regret of having made a bad investment. The embarrassment of having to report the loss to the accountants, family, friends and others may also contribute to the tendency not to sell losing investments.
Regret, theory deals with the emotional reaction people experience after realising they've made an error in judgment. Faced with the prospect of selling a stock, investors become emotionally affected by the price at which they purchased the stock. Some researchers theorise that investors follow the crowd to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect. Many investors find it easier to buy a popular stock and rationalise it going down since everyone else owned it and thought so highly of it. Buying a stock with a bad image is harder to rationalise if it goes down. Additionally, many believe that money managers and advisors favor well known and popular companies because they are less likely to be fired if they underperform.
What investors should really ask themselves when contemplating selling a stock is, “If this stock was already liquidated, would I but it again?” And, if the answer is “no” then it is time to sell the stock.
Perceiving risk
As per prospect theory, investors really want to know is not just how much an asset deviates from its expected outcome, but how bad things can get. Value at risk (VaR) attempts to provide an answer to this question. The idea behind VaR is to quantify how bad a loss on an investment could be with a given level of confidence over a defined period of time. For example, the following statement would be an example of VaR: "With about a 95% level of confidence, the most you stand to lose on this Rs10,000 investment over a two-year time horizon is Rs 2,000." The confidence level is a probability statement based on the statistical characteristics of the investment and the shape of its distribution curve, it is also known as standard deviation in statistics. However, this is not necessarily the worse case scenario as after all, 95% confidence allows that 5% of the time results may be much worse than what VaR calculates.
Mental accounting
John Allen Paulos states in his book Innumeracy, "There is a strong general tendency to filter out the bad and the failed and to focus on the good and the successful.”
Humans have a tendency to place particular events into mental compartments, and the difference between these compartments sometimes impacts our behavior more than the events themselves. Say, for example, you aim to catch a show at the local theater, and tickets are Rs. 200. When you get there you realize you've lost the Rs. 200 in your wallet. Do you buy a Rs. 200 worth ticket for the show anyway? Behaviour finance has found that roughly 88% of people in this situation would do so. Now, let's say you paid for the Rs 200 ticket in advance. When you arrive at the door, you realise your ticket is at home. Would you pay Rs 200 to purchase another? Only 40% of respondents would buy another. Notice, however, that in both scenarios you're spending Rs 400. An investing example of mental accounting is best illustrated by the hesitation to sell an investment that once had monstrous gains and now has a modest gain. During an economic boom and bull market, people get accustomed to healthy paper gains. When the market correction deflates investor's net worth, they're more hesitant to sell at the smaller profit margin. They create mental compartments for the gains they once had, causing them to wait for the return of that gainful period.
Finally
Many researchers believe that the study of psychology and other social sciences can shed considerable light on the efficiency of financial markets as well as explain many stock market anomalies, market bubbles, and crashes. As an example, some believe that the out performance of value investing results from investor's irrational overconfidence in exciting growth companies and from the fact that investors generate pleasure and pride from owning growth stocks. Many researchers (not all) believe that these human flaws are consistent, predictable, and can be exploited for profit.
The theory that most overtly opposes behavioural finance is the efficient market hypothesis (EMH), associated with Eugene Fama & Ken French (MIT). Their theory that market prices efficiently incorporate all available information depends on the premise that investors are rational. EMH proponents argue that events like those dealt with in behavioural finance are just short-term anomalies, or chance results, and that over the long term these anomalies disappear with a return to market efficiency.
Thus, there may not be enough evidence to suggest that market efficiency should be abandoned since empirical evidence shows that markets tend to correct themselves over the long term. In his book "Against the Gods: The Remarkable Story of Risk", Peter Bernste tells us. "While it is important to understand that the market doesn't work the way classical models think - there is a lot of evidence of herding, the behavioral finance concept of investors irrationally following the same course of action - but I don't know what you can do with that information to manage money. I remain unconvinced anyone is consistently making money out of it."
However, whether these behavioural finance theories can be used to manage your money effectively and economically is still a question mark. That said, investors can be their own worst enemies.
http://www.financialexpress.com/printer/news/497155/
FE Investor Bureau
Posted online: Aug 03, 2009 at 0006 hrs
Gamblers and mathematicians maybe familiar with what is known as the Martingale probability theory or the Martingale betting strategy and the theory is simple and works on the assumption that a gambler with infinite wealth will never loose. This assumption leads many to take disproportionate risks.
All one needs to do is say in simple games of heads or tails or any other gamble, is to keep doubling his bet after every loss. This will ensure that as and when you do win a bet, you will not only recover all your losses but also make a profit of the original sum you invested. Say for example you bet Rs. 1,000 on heads and loose. Then you double your bet to Rs. 2,000 and loose again. Then you continue playing and double your bet to Rs. 4,000 and loose yet again. Now, you bet yet again, and this time you bet Rs. 8,000.
Having, this time finally won you get Rs. 8,000 and have hence, not only recovered the loss of Rs. 7,00 you had previously incurred, but also make a profit of Rs. 1,000 (the original sum bet).
No, this is not a fool proof or sure shot method to always making money in a casino nor is it a gambling tip. The interesting point to be noted for those who practice this theory is that one’s risk aversion pattern contradicts financial prudence and relies more on emotions.
It is for this reason itself that gamblers often keep on playing even after loosing all the money they decided they could afford to loose, simply in the hope of winning. The reason he/she does not get up and leave the casino is not because they cannot afford that loss sustained, but simply the fact that their ego has been bruised and hurt, and no one likes to end up losing. Hence, in the hope of turning things around one keeps at it till, more often then not they are completely wiped out.
This kind of emotional gambling or making of financial decisions is seen in two extremes, one is when you’re losing and one is when you’re winning heavily. If human financial stupidity were to be depicted in a bell curve, one would see it having a very heavy tail and a very small head. The tail represents the losers which are far greater in number than the winners, and, both have ended up there due to their irrational decisions. In investing they are often termed as greed and fear, with greed making most people follow the madness of the mob, in the hope of making some profits, while fear is what often causes people to try and convert a loss into a profit no matter how slim the odds, often ending up with a bigger loss than needed. "Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear" said William Gross, in his book, “Everything You've Heard About Investing is Wrong!”
Prospect theory
This is a theory that believes people value gains and losses differently and, as such, will base decisions on perceived gains rather than perceived losses. Hence, if a person were given two choices, one expressed in terms of possible gains and the other in possible losses, even though both amount to the same, people would choose the former. It is also known as "loss-aversion theory".
Tversky and Kahneman originally described, "Prospect Theory" in 1979. They found that contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains.
Some economists have concluded that investors typically consider the loss of Rs.1,000 twice as painful as the pleasure received from a gain of the same amount. They also found that individuals will respond differently to equivalent situations depending on whether it is presented in the context of losses or gains. Researchers have also found that people are willing to take more risks to avoid losses than to realize gains. Faced with sure gain, most investors are risk-averse, but faced with sure loss, investors become risk-takers.
--------------------------------------------------------------------------------
Here is an example from Tversky and Kahneman's 1979 article. Kahneman and Tversky presented groups of subjects with a number of problems. One group of subjects was presented with this problem:
In addition to whatever you own, you have been given $1,000. You are now asked to choose between:
a. A sure gain of $500
b. A 50% change to gain $1,000 and a 50% chance to gain nothing.
Another group of subjects was presented with another problem.
In addition to whatever you own, you have been given $2,000. You are now asked to choose between:
a. A sure loss of $500
b. A 50% chance to lose $1,000 and a 50% chance to lose nothing.
In the first group 84% chose A. In the second group 69% chose (b). The two problems are identical in terms of net cash to the subject, however the phrasing of the question causes the problems to be interpreted differently.
--------------------------------------------------------------------------------
Peter L Bernstein in “Against the Gods states that the evidence "reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty."
Prospect theory also explains why investors hold onto losing stocks: people often take more risks to avoid losses than to realize gains. For this reason, investors willingly remain in a risky stock position, hoping the price will bounce back. The loss-aversion theory points to another reason why investors might choose to hold their losers and sell their winners: they may believe that today's losers may soon outperform today's winners. Investors often make the mistake of chasing market action by investing in stocks or funds which garner the most attention. Research shows that money flows into high-performance mutual funds more rapidly than money flows out from funds that are underperforming.
Regret theory
People tend to feel sorrow and grief after having made an error in judgment. Investors deciding whether to sell a security are typically emotionally affected by whether the security was bought for more or less than the current price. One theory is that investors avoid selling stocks that have gone down in order to avoid the pain and regret of having made a bad investment. The embarrassment of having to report the loss to the accountants, family, friends and others may also contribute to the tendency not to sell losing investments.
Regret, theory deals with the emotional reaction people experience after realising they've made an error in judgment. Faced with the prospect of selling a stock, investors become emotionally affected by the price at which they purchased the stock. Some researchers theorise that investors follow the crowd to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect. Many investors find it easier to buy a popular stock and rationalise it going down since everyone else owned it and thought so highly of it. Buying a stock with a bad image is harder to rationalise if it goes down. Additionally, many believe that money managers and advisors favor well known and popular companies because they are less likely to be fired if they underperform.
What investors should really ask themselves when contemplating selling a stock is, “If this stock was already liquidated, would I but it again?” And, if the answer is “no” then it is time to sell the stock.
Perceiving risk
As per prospect theory, investors really want to know is not just how much an asset deviates from its expected outcome, but how bad things can get. Value at risk (VaR) attempts to provide an answer to this question. The idea behind VaR is to quantify how bad a loss on an investment could be with a given level of confidence over a defined period of time. For example, the following statement would be an example of VaR: "With about a 95% level of confidence, the most you stand to lose on this Rs10,000 investment over a two-year time horizon is Rs 2,000." The confidence level is a probability statement based on the statistical characteristics of the investment and the shape of its distribution curve, it is also known as standard deviation in statistics. However, this is not necessarily the worse case scenario as after all, 95% confidence allows that 5% of the time results may be much worse than what VaR calculates.
Mental accounting
John Allen Paulos states in his book Innumeracy, "There is a strong general tendency to filter out the bad and the failed and to focus on the good and the successful.”
Humans have a tendency to place particular events into mental compartments, and the difference between these compartments sometimes impacts our behavior more than the events themselves. Say, for example, you aim to catch a show at the local theater, and tickets are Rs. 200. When you get there you realize you've lost the Rs. 200 in your wallet. Do you buy a Rs. 200 worth ticket for the show anyway? Behaviour finance has found that roughly 88% of people in this situation would do so. Now, let's say you paid for the Rs 200 ticket in advance. When you arrive at the door, you realise your ticket is at home. Would you pay Rs 200 to purchase another? Only 40% of respondents would buy another. Notice, however, that in both scenarios you're spending Rs 400. An investing example of mental accounting is best illustrated by the hesitation to sell an investment that once had monstrous gains and now has a modest gain. During an economic boom and bull market, people get accustomed to healthy paper gains. When the market correction deflates investor's net worth, they're more hesitant to sell at the smaller profit margin. They create mental compartments for the gains they once had, causing them to wait for the return of that gainful period.
Finally
Many researchers believe that the study of psychology and other social sciences can shed considerable light on the efficiency of financial markets as well as explain many stock market anomalies, market bubbles, and crashes. As an example, some believe that the out performance of value investing results from investor's irrational overconfidence in exciting growth companies and from the fact that investors generate pleasure and pride from owning growth stocks. Many researchers (not all) believe that these human flaws are consistent, predictable, and can be exploited for profit.
The theory that most overtly opposes behavioural finance is the efficient market hypothesis (EMH), associated with Eugene Fama & Ken French (MIT). Their theory that market prices efficiently incorporate all available information depends on the premise that investors are rational. EMH proponents argue that events like those dealt with in behavioural finance are just short-term anomalies, or chance results, and that over the long term these anomalies disappear with a return to market efficiency.
Thus, there may not be enough evidence to suggest that market efficiency should be abandoned since empirical evidence shows that markets tend to correct themselves over the long term. In his book "Against the Gods: The Remarkable Story of Risk", Peter Bernste tells us. "While it is important to understand that the market doesn't work the way classical models think - there is a lot of evidence of herding, the behavioral finance concept of investors irrationally following the same course of action - but I don't know what you can do with that information to manage money. I remain unconvinced anyone is consistently making money out of it."
However, whether these behavioural finance theories can be used to manage your money effectively and economically is still a question mark. That said, investors can be their own worst enemies.
http://www.financialexpress.com/printer/news/497155/
Talent without soul
Talent without soul
by Dave C from live comments
It's usually not the class presidents or those with higher intellect that make it in this world. It's those that struggle in school and when entering the workplace. Those that have to work hard to make their way are the ones that become the millionaires and business owners, a lot of times employing those that fared much better than they themselves did during school. It's those seventeen year old kids that work nights and weekends after school, learning that hard work and pride in one's work are the future millionaires and business owners. It took the reading of two books to wake me up and show me where I had gone wrong. Both books are by Thomas J. Stanley, entitled The Millionaire Next Door and The Millionaire Mind
How many artists who have showed great talent, some even being labeled as "naturals," have struggled because their work, while showing lots of talent, displayed no life or soul? How many of these artists feel that all they have to do is drip a little paint on a canvas or draw half a dozen lines with a piece of charcoal and the world will be falling down at their feet, ready to proclaim them the next Wyeth or Pollock? I've attended art events and have run into this type of artist who, if you question their art, act as if you are beneath contempt, that their art needs no explanation or justification. It is what it is.
Some of us are labeled "winner" early on and it's the worst thing that can happen to us. Others get the "loser" tag affixed to them and, if they can survive it and look past it, they become some of the most successful in whatever field of endeavor they choose. Maybe, some day, we'll stop all this nonsense of teaching our children that they are special and they are winners without even lifting a finger, and get back to teaching them how to take pride in hard work and craftsmanship, leading them to much more fulfilling and useful lives.
http://clicks.robertgenn.com/winners-losers.php
by Dave C from live comments
It's usually not the class presidents or those with higher intellect that make it in this world. It's those that struggle in school and when entering the workplace. Those that have to work hard to make their way are the ones that become the millionaires and business owners, a lot of times employing those that fared much better than they themselves did during school. It's those seventeen year old kids that work nights and weekends after school, learning that hard work and pride in one's work are the future millionaires and business owners. It took the reading of two books to wake me up and show me where I had gone wrong. Both books are by Thomas J. Stanley, entitled The Millionaire Next Door and The Millionaire Mind
How many artists who have showed great talent, some even being labeled as "naturals," have struggled because their work, while showing lots of talent, displayed no life or soul? How many of these artists feel that all they have to do is drip a little paint on a canvas or draw half a dozen lines with a piece of charcoal and the world will be falling down at their feet, ready to proclaim them the next Wyeth or Pollock? I've attended art events and have run into this type of artist who, if you question their art, act as if you are beneath contempt, that their art needs no explanation or justification. It is what it is.
Some of us are labeled "winner" early on and it's the worst thing that can happen to us. Others get the "loser" tag affixed to them and, if they can survive it and look past it, they become some of the most successful in whatever field of endeavor they choose. Maybe, some day, we'll stop all this nonsense of teaching our children that they are special and they are winners without even lifting a finger, and get back to teaching them how to take pride in hard work and craftsmanship, leading them to much more fulfilling and useful lives.
http://clicks.robertgenn.com/winners-losers.php
Why The Rich Get Richer And How You Can Do So Too
Why The Rich Get Richer And How You Can Do So Too
By: Joel Teo
The Italian once said “There are only three ways to make money – you can steal it, marry it, or inherit it." Many would argue that they missed one very important method – investment. In fact it is why the rich get richer and how you can do so too.
Just ask the young man who invested his last nickel during the Great Depression. He invested in an apple doubled his money the same day and repeated the process slowly building a small fortune. Of course the two million dollars his parents left him certainly allowed him to invest even more seriously. It's why the rich get richer and how you can do so too.
What about Bill Gates who took great personal risks that gave him an industry monopoly. Of course the fact that his grandparents left him a million dollar trust fund and that his mother personally knew the CEO at IBM who would eventually seal the deal doesn't really make for a fair playing field. So is why the rich get richer and how you can do so too really doable?
Let's have a look at Donald Trump who inherited millions of dollars from his father so no matter what success he's had over the years he would have been wealthy anyway. It's why the rich get richer and how you can do so too – that is if you can pick your parents.
Since most of us can't pick our parents we'd better have a look at investing is some common stocks. If you are investing long term stocks are a good start. And it is why the rich get richer and how you can do so too. It doesn't favor rich or poor as long as you have the money for the stocks.
Mutual funds are also a good choice for long term with a lot less risk. Use a funds manager and you're going to deal with a funds load which is a percentage they take each year. But why not be your own manager and eliminate that cost which can add up. That's why the rich get richer and how you can do so too.
If you haven't figured out why the rich get richer and how you can do so too you need to do just a little more research and reading. You'll figure it out in no time and you will have the formula for why the rich get richer and how you can do so too.
http://www.streetdirectory.com/travel_guide/12761/how_to_grow_wealth/why_the_rich_get_richer_and_how_you_can_do_so_too.html
By: Joel Teo
The Italian once said “There are only three ways to make money – you can steal it, marry it, or inherit it." Many would argue that they missed one very important method – investment. In fact it is why the rich get richer and how you can do so too.
Just ask the young man who invested his last nickel during the Great Depression. He invested in an apple doubled his money the same day and repeated the process slowly building a small fortune. Of course the two million dollars his parents left him certainly allowed him to invest even more seriously. It's why the rich get richer and how you can do so too.
What about Bill Gates who took great personal risks that gave him an industry monopoly. Of course the fact that his grandparents left him a million dollar trust fund and that his mother personally knew the CEO at IBM who would eventually seal the deal doesn't really make for a fair playing field. So is why the rich get richer and how you can do so too really doable?
Let's have a look at Donald Trump who inherited millions of dollars from his father so no matter what success he's had over the years he would have been wealthy anyway. It's why the rich get richer and how you can do so too – that is if you can pick your parents.
Since most of us can't pick our parents we'd better have a look at investing is some common stocks. If you are investing long term stocks are a good start. And it is why the rich get richer and how you can do so too. It doesn't favor rich or poor as long as you have the money for the stocks.
Mutual funds are also a good choice for long term with a lot less risk. Use a funds manager and you're going to deal with a funds load which is a percentage they take each year. But why not be your own manager and eliminate that cost which can add up. That's why the rich get richer and how you can do so too.
If you haven't figured out why the rich get richer and how you can do so too you need to do just a little more research and reading. You'll figure it out in no time and you will have the formula for why the rich get richer and how you can do so too.
http://www.streetdirectory.com/travel_guide/12761/how_to_grow_wealth/why_the_rich_get_richer_and_how_you_can_do_so_too.html
8 Rules of Building Wealth
8 Rules of Building Wealth By: Alan L. Olsen
1. Forget Performance; look at fees
Remember that it’s not what you make, it’s what you keep. When evaluating an investment evaluate the cost to generate an investment return. If you are using an investment manager compare the performance of the investment net of fees. Be careful when entering into non-tradition investment vehicles life limited partnership interest. These type of investments tend to have higher management fees and are often illiquid.
2. Invest when a stock's earnings estimate are being revised upward.
Investing when a stock is strong is often a sign of good management and strong underlying value. Be focused on stocks that are reaching new highs because the management is committed to increasing the stock value. Look for stocks that announce buyback programs. This is often a sign that management feels the stock is undervalued. If the insiders feel that way, its often a great sign that you should be buying the stock too.
3. Monitor cash flow to find the winners
Increased cash flow into a company is a great sign that the company is fundamentally strong. With increased cash flow that company has the ability to pay increased dividends and expand without taking on a lot of debt.
4. Put the right investments in the right places
Don’t just buy an investment because everyone else is. The best investment policy is found in a balanced portfolio and outlines investment objectives. For example, if you are young and starting out your career, you should be heavily weighted into stocks and making investments with greater potential returns. A person in the retirement, should adopt an investment policy that focuses on predictable cash flow and protection of principal.
5. Forget 1 year outlooks; plan at least 5 or 10 years ahead
Even the best professional investment advisors cannot predict what is going to be the best performer for the next year. The best investment policy is reached by taking a long term perspective in mind. When you invest, invest for the long term. Be patience and allow your portfolio to experience volatility. If you are worrying about your investments, then you have too much invested. Only invest what you are afford to lose.
6. Don't be afraid to hold cash
You should set aside some cash outside of the electronic banking system. If you were to experience a disaster your credit cards may no longer work, but your cash will. Hold enough cash to manage your affairs for at least 4 days (or 72 hours).
7. Follow the outstanding shares
When evaluating a company be sure to check who is currently holding the stock. How much institutional shares are invested. Institutional share give more stability to the stock unless bad news is announced. If the stock is quickly dumped by the institution, this will probably result in a large drop on the market. Look for companies that have less than 50% of the outstanding stock in institutions. This may bring a greater up side if you are holding stock and the institutions are looking to acquire large blocks. Also, companies with stock buyback programs are a good sign the companies stock is undervalued.
8. Don't rely on your instincts; they're probably wrong
Most people learn this lesson the hard way. If everyone is dumping a stock, that doesn’t mean that you should also be buying. Do no try to time the market in a stock. Remember the saying: “Lows hit new lows and highs hit new highs". The best investment policy is one that adopts a slow steady pace.
http://www.streetdirectory.com/travel_guide/143305/how_to_grow_wealth/8_rules_of_building_wealth.html
1. Forget Performance; look at fees
Remember that it’s not what you make, it’s what you keep. When evaluating an investment evaluate the cost to generate an investment return. If you are using an investment manager compare the performance of the investment net of fees. Be careful when entering into non-tradition investment vehicles life limited partnership interest. These type of investments tend to have higher management fees and are often illiquid.
2. Invest when a stock's earnings estimate are being revised upward.
Investing when a stock is strong is often a sign of good management and strong underlying value. Be focused on stocks that are reaching new highs because the management is committed to increasing the stock value. Look for stocks that announce buyback programs. This is often a sign that management feels the stock is undervalued. If the insiders feel that way, its often a great sign that you should be buying the stock too.
3. Monitor cash flow to find the winners
Increased cash flow into a company is a great sign that the company is fundamentally strong. With increased cash flow that company has the ability to pay increased dividends and expand without taking on a lot of debt.
4. Put the right investments in the right places
Don’t just buy an investment because everyone else is. The best investment policy is found in a balanced portfolio and outlines investment objectives. For example, if you are young and starting out your career, you should be heavily weighted into stocks and making investments with greater potential returns. A person in the retirement, should adopt an investment policy that focuses on predictable cash flow and protection of principal.
5. Forget 1 year outlooks; plan at least 5 or 10 years ahead
Even the best professional investment advisors cannot predict what is going to be the best performer for the next year. The best investment policy is reached by taking a long term perspective in mind. When you invest, invest for the long term. Be patience and allow your portfolio to experience volatility. If you are worrying about your investments, then you have too much invested. Only invest what you are afford to lose.
6. Don't be afraid to hold cash
You should set aside some cash outside of the electronic banking system. If you were to experience a disaster your credit cards may no longer work, but your cash will. Hold enough cash to manage your affairs for at least 4 days (or 72 hours).
7. Follow the outstanding shares
When evaluating a company be sure to check who is currently holding the stock. How much institutional shares are invested. Institutional share give more stability to the stock unless bad news is announced. If the stock is quickly dumped by the institution, this will probably result in a large drop on the market. Look for companies that have less than 50% of the outstanding stock in institutions. This may bring a greater up side if you are holding stock and the institutions are looking to acquire large blocks. Also, companies with stock buyback programs are a good sign the companies stock is undervalued.
8. Don't rely on your instincts; they're probably wrong
Most people learn this lesson the hard way. If everyone is dumping a stock, that doesn’t mean that you should also be buying. Do no try to time the market in a stock. Remember the saying: “Lows hit new lows and highs hit new highs". The best investment policy is one that adopts a slow steady pace.
http://www.streetdirectory.com/travel_guide/143305/how_to_grow_wealth/8_rules_of_building_wealth.html
Has the stock market rise disturbed your portfolio?
Has the stock market rise disturbed your portfolio?
Consider this, suppose the prices of potato, ghee and sugar dropped to half, would you double your consumption and reduce that of the other food stuffs? Unlikely! You eat a balanced diet and a sudden price change does not make you change your diet drastically. Why then, should you behave differently with your money life and increase the proportion of an asset just because its price has taken its value higher? Rebalancing is a smart way to keep the portfolio suited to your risk and return needs.
Every portfolio has a mix of different instruments - debt, equity and cash. Debt, or interest-bearing instruments like bonds, income mutual funds and deposits, give low risk moderate returns, equity, or shares and stock market mutual funds, is risky and can give higher returns. Cash is the emergency and opportunity fund that gives very low returns, but is liquid and safe. Ideally, as a person ages, he should reduce the equity part of his portfolio and increase the lower risk debt since the risk-taking capacity goes down with age.
At each age and stage in life, each person will have his own unique asset allocation that works for his risk and return needs. For example, a 38 year old person may have an asset allocation of 60 per cent in equity and 40 per cent in debt and a 60 year old could have 20 per cent in equity and 80 per cent in debt. The idea is to stay at the chosen asset allocation at a particular age, even if the markets keep changing. Therefore the need for rebalancing.
Rebalancing the portfolio means coming back to the original asset allocation at least once a year, as markets take the value of the portfolio up or down. Consider this: in April 2003, a 38 year old with a 60:40 asset allocation in equity and debt has Rs 10 lakh in his portfolio. This means he has Rs 6 lakh worth of shares and equity mutual funds and Rs 4 lakh worth of debt paper like bank fixed deposits, debentures, bonds and funds. Now, almost a year later, the rising stock market has taken the collected value of his equity portfolio to Rs 12 lakh - his State Bank shares rose sharply, the index funds went up and so on, but his debt did not gain since interest rates did not fall and there was no capital gain on his bond funds. Now his asset allocation is Rs 12 lakh: Rs 4 lakh or 75:25 without him making any fresh investments or changing any older investments simply because the market took the equity value of his portfolio higher.
But this person had been comfortable with a 60:40 asset allocation, should he be at 75:25? No, he should go back to his original asset allocation, if he feels he cannot expose his portfolio to this higher level of risk. He can do two things:
Sell a part of his equity holdings to book profit and buy debt. It is difficult to sell the winner to buy the loser, specially when it looks as if the markets will keep rising. But remember, that if you don't rebalance, the market may do it for you and you will lose the profit you could have booked. Don't sell your entire holding of a favourite stock, sell a part of it and use the money to buy into debt instruments.
Make all fresh investments in debt. This may be difficult as such a large amount of money may not be available to bring the asset allocation back to the original level. It also prevents the person from booking profit, but it is an option for a person reluctant to sell in a rising market and yet needing to rebalance.
Booking profit to come back to your original equity-debt split is a smart strategy as it allows you to enjoy the gains and yet keep the desired proportion between assets intact. Remember to check on the tax angle before you sell. Sometimes it may be better wait a couple of months to become eligible for the lower long term capital gains tax. Sometimes it may be good to sell some stocks that have lost along with some winners to offset the losses to the gains.
How often should you rebalance?
Rebalance your portfolio once a year. Do it around tax investment time as your focus is already on money matters. Rebalance in the interim, if you feel that one asset class has suddenly shot up alarmingly. For example, the stock market vroom since April 2003 should be making you re-look at your portfolio now. But don't micromanage and churn for every percentage change in the asset allocation. A sustained 10 to 15 per cent change is the trigger to rebalance.
Is there some way to automatically rebalance?
If you find the job of managing your portfolio too heavy and rebalancing is a word you don't even want to hold, look at mutual funds. The newly launched fund of funds category is the most efficient way to follow the rebalancing strategy. A fund of fund invests in other mutual fund schemes. Fund houses like Birla Sun Life Mutual Fund and Prudential ICICI are offering different asset allocations to suit investment needs that will automatically rebalance according to the chosen asset allocation.
When should you not rebalance?
If you feel that your risk profile has changed and you can take higher risk, you can let your portfolio run on and not book profits. This is a high risk strategy, be aware of the risk and then do it, if it suits your profile.
http://www.indianexpress.com/oldStory/39393/
Consider this, suppose the prices of potato, ghee and sugar dropped to half, would you double your consumption and reduce that of the other food stuffs? Unlikely! You eat a balanced diet and a sudden price change does not make you change your diet drastically. Why then, should you behave differently with your money life and increase the proportion of an asset just because its price has taken its value higher? Rebalancing is a smart way to keep the portfolio suited to your risk and return needs.
Every portfolio has a mix of different instruments - debt, equity and cash. Debt, or interest-bearing instruments like bonds, income mutual funds and deposits, give low risk moderate returns, equity, or shares and stock market mutual funds, is risky and can give higher returns. Cash is the emergency and opportunity fund that gives very low returns, but is liquid and safe. Ideally, as a person ages, he should reduce the equity part of his portfolio and increase the lower risk debt since the risk-taking capacity goes down with age.
At each age and stage in life, each person will have his own unique asset allocation that works for his risk and return needs. For example, a 38 year old person may have an asset allocation of 60 per cent in equity and 40 per cent in debt and a 60 year old could have 20 per cent in equity and 80 per cent in debt. The idea is to stay at the chosen asset allocation at a particular age, even if the markets keep changing. Therefore the need for rebalancing.
Rebalancing the portfolio means coming back to the original asset allocation at least once a year, as markets take the value of the portfolio up or down. Consider this: in April 2003, a 38 year old with a 60:40 asset allocation in equity and debt has Rs 10 lakh in his portfolio. This means he has Rs 6 lakh worth of shares and equity mutual funds and Rs 4 lakh worth of debt paper like bank fixed deposits, debentures, bonds and funds. Now, almost a year later, the rising stock market has taken the collected value of his equity portfolio to Rs 12 lakh - his State Bank shares rose sharply, the index funds went up and so on, but his debt did not gain since interest rates did not fall and there was no capital gain on his bond funds. Now his asset allocation is Rs 12 lakh: Rs 4 lakh or 75:25 without him making any fresh investments or changing any older investments simply because the market took the equity value of his portfolio higher.
But this person had been comfortable with a 60:40 asset allocation, should he be at 75:25? No, he should go back to his original asset allocation, if he feels he cannot expose his portfolio to this higher level of risk. He can do two things:
Sell a part of his equity holdings to book profit and buy debt. It is difficult to sell the winner to buy the loser, specially when it looks as if the markets will keep rising. But remember, that if you don't rebalance, the market may do it for you and you will lose the profit you could have booked. Don't sell your entire holding of a favourite stock, sell a part of it and use the money to buy into debt instruments.
Make all fresh investments in debt. This may be difficult as such a large amount of money may not be available to bring the asset allocation back to the original level. It also prevents the person from booking profit, but it is an option for a person reluctant to sell in a rising market and yet needing to rebalance.
Booking profit to come back to your original equity-debt split is a smart strategy as it allows you to enjoy the gains and yet keep the desired proportion between assets intact. Remember to check on the tax angle before you sell. Sometimes it may be better wait a couple of months to become eligible for the lower long term capital gains tax. Sometimes it may be good to sell some stocks that have lost along with some winners to offset the losses to the gains.
How often should you rebalance?
Rebalance your portfolio once a year. Do it around tax investment time as your focus is already on money matters. Rebalance in the interim, if you feel that one asset class has suddenly shot up alarmingly. For example, the stock market vroom since April 2003 should be making you re-look at your portfolio now. But don't micromanage and churn for every percentage change in the asset allocation. A sustained 10 to 15 per cent change is the trigger to rebalance.
Is there some way to automatically rebalance?
If you find the job of managing your portfolio too heavy and rebalancing is a word you don't even want to hold, look at mutual funds. The newly launched fund of funds category is the most efficient way to follow the rebalancing strategy. A fund of fund invests in other mutual fund schemes. Fund houses like Birla Sun Life Mutual Fund and Prudential ICICI are offering different asset allocations to suit investment needs that will automatically rebalance according to the chosen asset allocation.
When should you not rebalance?
If you feel that your risk profile has changed and you can take higher risk, you can let your portfolio run on and not book profits. This is a high risk strategy, be aware of the risk and then do it, if it suits your profile.
http://www.indianexpress.com/oldStory/39393/
Some Investing Principles which cannot be disputed
While it may be true that in the online investing world there is no rule without an exception, there are some principles which cannot be disputed. These principles can help investors get a better grasp of how to approach online investments and nurture them to maturity.
Sell the losers and let the winners keep riding
For long term investing success it is important to ride a winner. Ever so often, investors make profits by selling their appreciated online stocks, but hold onto stocks that have declined in hopes of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice.
If you have a personal preference to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever succeeded.. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting.
While riding a winner is important, you also should sell the losers. There is no guarantee that an online stock will bounce back after a long period of decline. While it is important not to underestimate good stocks, it is equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses.
Learn to give a cold shoulder to hot tips
Whether the tip comes from your brother, cousin, neighbor or even online broker, no one can ever guarantee what online stocks will do. When you make an investment, it's important you know the reasons for doing so. Conduct your own research and analysis of any company before you even consider investing your hard earned money. Relying on a hot tip from someone else is not only an attempt at taking the easy way out, it is also a big gamble. Sure, with some luck, tips may sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run.
Don't panic when shares experience short-term movements
As a long term online investing strategy, you should not panic when your online investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term.
Day traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.
Do not overemphasize the P/E ratio
Investors often place too much importance on the price-to-earning (P/E) ratio in their online investing strategy. It is one key tool among many. Using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is over valued.
Resist the temptation of penny stocks
A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you'd still have a 100% loss of your initial investment. A penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.
Stick to your strategy
Online stock investors use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick to it. An investor who switches between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors aiming at long term strategies should avoid.
While these suggestions cover some critical strategies for long-term online investments there is an exception to every rule. Depending on your circumstances, use these principles within the framework of your overall investment strategy, and reap the benefits of long term online investments.
http://www.1einvestonline.com/online-stock-investors.html
Sell the losers and let the winners keep riding
For long term investing success it is important to ride a winner. Ever so often, investors make profits by selling their appreciated online stocks, but hold onto stocks that have declined in hopes of a rebound. If an investor doesn't know when it's time to let go of hopeless stocks, he or she can, in the worst-case scenario, see the stock sink to the point where it is almost worthless. Of course, the idea of holding onto high-quality investments while selling the poor ones is great in theory, but hard to put into practice.
If you have a personal preference to sell after a stock has increased by a certain multiple - say three, for instance - you may never fully ride out a winner. No one in the history of investing with a "sell-after-I-have-tripled-my-money" mentality has ever succeeded.. Don't underestimate a stock that is performing well by sticking to some rigid personal rule - if you don't have a good understanding of the potential of your investments, your personal rules may end up being arbitrary and too limiting.
While riding a winner is important, you also should sell the losers. There is no guarantee that an online stock will bounce back after a long period of decline. While it is important not to underestimate good stocks, it is equally important to be realistic about investments that are performing badly. Recognizing your losers is hard because it's also an acknowledgment of your mistake. But it's important to be honest when you realize that a stock is not performing as well as you expected it to. Don't be afraid to swallow your pride and move on before your losses become even greater.
In both cases, the point is to judge companies on their merits according to your research. In each situation, you still have to decide whether a price justifies future potential. Just remember not to let your fears limit your returns or inflate your losses.
Learn to give a cold shoulder to hot tips
Whether the tip comes from your brother, cousin, neighbor or even online broker, no one can ever guarantee what online stocks will do. When you make an investment, it's important you know the reasons for doing so. Conduct your own research and analysis of any company before you even consider investing your hard earned money. Relying on a hot tip from someone else is not only an attempt at taking the easy way out, it is also a big gamble. Sure, with some luck, tips may sometimes pan out. But they will never make you an informed investor, which is what you need to be to be successful in the long run.
Don't panic when shares experience short-term movements
As a long term online investing strategy, you should not panic when your online investments experience short-term movements. When tracking the activities of your investments, you should look at the big picture. Remember to be confident in the quality of your investments rather than nervous about the inevitable volatility of the short term.
Day traders will use these day-to-day and even minute-to-minute fluctuations as a way to make gains. But the gains of a long-term investor come from a completely different market movement - the one that occurs over many years - so keep your focus on developing your overall investment philosophy by educating yourself.
Do not overemphasize the P/E ratio
Investors often place too much importance on the price-to-earning (P/E) ratio in their online investing strategy. It is one key tool among many. Using only this ratio to make buy or sell decisions is dangerous and ill-advised. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes. So, a low P/E ratio doesn't necessarily mean a security is undervalued, nor does a high P/E ratio necessarily mean a company is over valued.
Resist the temptation of penny stocks
A common misconception is that there is less to lose in buying a low-priced stock. But whether you buy a $5 stock that plunges to $0 or a $75 stock that does the same, either way you'd still have a 100% loss of your initial investment. A penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.
Stick to your strategy
Online stock investors use different methods to pick stocks and fulfill investing goals. There are many ways to be successful and no one strategy is inherently better than any other. However, once you find your style, stick to it. An investor who switches between different stock-picking strategies will probably experience the worst, rather than the best, of each. Constantly switching strategies effectively makes you a market timer, and this is definitely territory most investors aiming at long term strategies should avoid.
While these suggestions cover some critical strategies for long-term online investments there is an exception to every rule. Depending on your circumstances, use these principles within the framework of your overall investment strategy, and reap the benefits of long term online investments.
http://www.1einvestonline.com/online-stock-investors.html
When To Sell Your Stocks
When To Sell Your Stocks
David Serchuk 03.04.09, 6:00 PM ET
We sell our winners too early and ride the losers straight into the ground. This self-destructive pattern even has a name. It's called the "disposition effect."
Why do we do it? Ravi Dhar and Ning Zhu of the Yale School of Management believe that the disposition effect is real but that professional investors are less prone to it. One reason is because such investors are more able to confront bad news and admit error. But the madding crowd seems to lack this armor. Basically, we can't handle the truth.
To deal with such messy, emotional, but real issues we convened a special, more intimate meeting of the Forbes.com Investor Team. On one side of the table we have Michael Ervolini, the head of Cabot Research, which applies behavioral finance to its mostly institutional client base. Behavioral finance applies the lens of psychology to the seemingly cold, rational world of business and investing. On the other side of the discussion we have Marc Lowlicht, the head of the wealth management division of Further Lane Asset Management. Lowlicht is on the front lines, dealing with unhappy, stressed customers who feel panicked and powerless as their portfolios shrink.
What Ervolini has found is that many of our seemingly rational decisions--good or bad--are based on emotions hard-wired into us. Greed, embarrassment and shame are often in the driver's seat, no matter how much we would like to think otherwise.
In the case of stock sales, here's the problem: it's been documented that the pain of losing money is twice greater than the joy of making it. So if you buy a stock and it goes up $2, you're tempted to sell. Investors love to take small gains off the table. If it goes down $1, most investors will refuse to take the loss. They will hang onto the loser in the hopes of making that dollar back. That $1 loss has as strong an effect on the brain as a $2 gain.
"As long as the loss is hanging in the portfolio it has a chance of coming back," Ervolini says. "But once you sell a position, that position is a loser forever and a little bit of you is a loser forever."
Another problem Ervolini has found is that the same part of the brain that reacts with horror to death and disease is the one that's affected by financial losses. This stretches far back in our evolutionary history. In less civilized times, a financial loss, or the loss of a source of gathered or hoarded food, could lead quickly to death. We react the same way to the nest egg that's meant to see us through retirement.
There is very little research on the subject of stock sales. Ervolini found just one paper. But as shown by the recent market meltdown, selling is often the more critical skill.
Another issue Lowlicht confronts is that his customers often don't understand that there can be no real growth without some risk. The problem, Ervolini counters, is that so few of us truly know how much loss we can bear. Often it is much less than we initially believe. "Know Thyself" might be a classic ideal but for many it remains just that.
Why We Can't Sell
Forbes: Mike, one thing you've mentioned is the anti-selling bias. You can be a good buyer of securities or a good seller, but usually people aren't both. Why is there this anti-selling bias?
Michael Ervolini: Well, I can relate it to [mutual fund] managers and then we can try to then relate it to individuals. From managers, there's a technical and an emotional explanation. The technical one is that for the past 30 years virtually every dollar invested in studying the strategic part of investing has been about buying. It's research for ranking stocks. It's portfolio risk management. It's optimizers. It's tools that do attribution analysis and on and on. It's all looking at what you own and what you're going to buy today. We did some extensive work on this and we found one academic article on selling.
Forbes: One? Was it a good article?
Ervolini: It was pretty good.
Marc Lowlicht: Compared to the others, it was great.
Ervolini: And there are no real heavy books on the subject. Everybody's oriented toward buying in terms of the profession. We talked to the people at Tower Research who do financial research. They agreed that 80% or more of the dollars that they see invested are on buying. In terms of research, capital, etc. So selling has just been under-served from the industry's perspective.
Our academic adviser, Terrance Odean [the Willis H. Booth Professor of Banking and Finance at the Haas School of Business at the University of California, Berkeley] has expressed a behavioral approach this way: When you buy something--and we're looking at long portfolios for a second--it's out of hope. What can this position do for me? It's a pretty nice place to be. When you sell, it's because of what the position did to you. And maybe there's just some natural inclination to want to spend more time thinking about buying because it's just a more pleasant thought process as opposed to selling. But, I can tell you we've looked at just scores and scores and scores of funds and we see it over and over again.
And when we talk to professional managers, it resonates. "Yeah, I have some concerns about my selling and I'm glad to be able to have a really thorough examination of just my selling. Because I know I can make it better." And it's they don't have in their organization feedback mechanisms to help them do it.
Lowlicht: Can I add something else in there that I've observed? Part of my business is to understand how people think because I have to guide them based on that. I think another reason people are better buyers than sellers is because when you buy, there's no tally to how you did. If you lose, it's a paper loss. "It's still a good company. It's going to come back." But when you finally sell something, if it goes higher, you sold too soon. If it goes lower, you made the right decision. If you outperformed, you did great. So, people like to be winners. People like to be right. That's why people argue. And when you buy, there is no weighing system as to whether you're right or wrong until the sale is made. So, it's much easier not to second guess a purchase.
And even if you bought Citigroup at $12, you can make a hundred excuses why you think it's going to $20. You still made the right decision. And right now, it's just a paper loss … But once you make a sale, your decision has been final and there's an accounting for the decision you made.
Ervolini: In behavioral finance, exactly what Marc's talking about is known as the disposition effect. And what we see repeatedly is that people love to take small gains off the table. We see it repeatedly, retail and institutional. People love to take gains for two reasons. Ten $1 gains make us feel better than one $10 gain. That's just the way our brains work. We like lots of small rewards as opposed to one big one. And once the gain starts to get up there, like $3-$4, we get fearful that the market will take it away. So, those two motivations cause us to take gains early.
And with losses it's what Marc was saying. As long as the loss is hanging in the portfolio, it has a chance of coming back. And we can postpone the self recrimination. But once you sell a position, that position is a loser forever and a little bit of you is a loser forever.
The other thing to keep in mind is that studies have shown that the emotional high we get from a dollar of win is only half the emotional low we get from losing a dollar. So a loss is twice as impactful as a win in money. We hate to lose and it's something primitive.
Forbes: Do investors really believe there is no reward without risk?
Ervolini: Oh, there's always a trade-off. When you allay someone's fears by changing their investment strategy, you're giving up return. And there's no way around that. The problem is the general investing public is misled into believing that return is magically created with no risk.
Lowlicht: And I think one of the problems is people want something for nothing almost. I don't know if that's the right terminology, but they have expectations of receiving, but don't consider what they give up. And they want to believe that there's a free lunch, that there's an easier way to do it. Or that somebody else has figured it out. Nobody else has figured it out. You've got a certain amount of return for the amount of risk you take. The more risk you take, the greater the return. The less risk you take, the less the return.
Ervolini: This is tough because one of the things we're not good at appreciating today is what a future outcome will feel like. And so, if Marc's interviewing me and he says to me, "Mike, can you handle a 5% draw down on your account?" I say, "Yeah, sure." And he says, "How about 10%?" I say, "Yeah, sure." And then he keeps going on and on. And he finally gets to a number where I say ouch. Let's say it's 40%. So now, based on his interview, Marc has a sense of one dimension of my risk tolerance. And then what happens is we're running down the road and my account gets drawn down 12% and I'm on the phone begging him to help me. Because I can't really appreciate what a 10% or 15% draw down feels like until I get there.
See More Intelligent Investing Features.
http://www.forbes.com/2009/03/04/psychology-selling-stocks-intelligent-investing_psychology.html
David Serchuk 03.04.09, 6:00 PM ET
We sell our winners too early and ride the losers straight into the ground. This self-destructive pattern even has a name. It's called the "disposition effect."
Why do we do it? Ravi Dhar and Ning Zhu of the Yale School of Management believe that the disposition effect is real but that professional investors are less prone to it. One reason is because such investors are more able to confront bad news and admit error. But the madding crowd seems to lack this armor. Basically, we can't handle the truth.
To deal with such messy, emotional, but real issues we convened a special, more intimate meeting of the Forbes.com Investor Team. On one side of the table we have Michael Ervolini, the head of Cabot Research, which applies behavioral finance to its mostly institutional client base. Behavioral finance applies the lens of psychology to the seemingly cold, rational world of business and investing. On the other side of the discussion we have Marc Lowlicht, the head of the wealth management division of Further Lane Asset Management. Lowlicht is on the front lines, dealing with unhappy, stressed customers who feel panicked and powerless as their portfolios shrink.
What Ervolini has found is that many of our seemingly rational decisions--good or bad--are based on emotions hard-wired into us. Greed, embarrassment and shame are often in the driver's seat, no matter how much we would like to think otherwise.
In the case of stock sales, here's the problem: it's been documented that the pain of losing money is twice greater than the joy of making it. So if you buy a stock and it goes up $2, you're tempted to sell. Investors love to take small gains off the table. If it goes down $1, most investors will refuse to take the loss. They will hang onto the loser in the hopes of making that dollar back. That $1 loss has as strong an effect on the brain as a $2 gain.
"As long as the loss is hanging in the portfolio it has a chance of coming back," Ervolini says. "But once you sell a position, that position is a loser forever and a little bit of you is a loser forever."
Another problem Ervolini has found is that the same part of the brain that reacts with horror to death and disease is the one that's affected by financial losses. This stretches far back in our evolutionary history. In less civilized times, a financial loss, or the loss of a source of gathered or hoarded food, could lead quickly to death. We react the same way to the nest egg that's meant to see us through retirement.
There is very little research on the subject of stock sales. Ervolini found just one paper. But as shown by the recent market meltdown, selling is often the more critical skill.
Another issue Lowlicht confronts is that his customers often don't understand that there can be no real growth without some risk. The problem, Ervolini counters, is that so few of us truly know how much loss we can bear. Often it is much less than we initially believe. "Know Thyself" might be a classic ideal but for many it remains just that.
Why We Can't Sell
Forbes: Mike, one thing you've mentioned is the anti-selling bias. You can be a good buyer of securities or a good seller, but usually people aren't both. Why is there this anti-selling bias?
Michael Ervolini: Well, I can relate it to [mutual fund] managers and then we can try to then relate it to individuals. From managers, there's a technical and an emotional explanation. The technical one is that for the past 30 years virtually every dollar invested in studying the strategic part of investing has been about buying. It's research for ranking stocks. It's portfolio risk management. It's optimizers. It's tools that do attribution analysis and on and on. It's all looking at what you own and what you're going to buy today. We did some extensive work on this and we found one academic article on selling.
Forbes: One? Was it a good article?
Ervolini: It was pretty good.
Marc Lowlicht: Compared to the others, it was great.
Ervolini: And there are no real heavy books on the subject. Everybody's oriented toward buying in terms of the profession. We talked to the people at Tower Research who do financial research. They agreed that 80% or more of the dollars that they see invested are on buying. In terms of research, capital, etc. So selling has just been under-served from the industry's perspective.
Our academic adviser, Terrance Odean [the Willis H. Booth Professor of Banking and Finance at the Haas School of Business at the University of California, Berkeley] has expressed a behavioral approach this way: When you buy something--and we're looking at long portfolios for a second--it's out of hope. What can this position do for me? It's a pretty nice place to be. When you sell, it's because of what the position did to you. And maybe there's just some natural inclination to want to spend more time thinking about buying because it's just a more pleasant thought process as opposed to selling. But, I can tell you we've looked at just scores and scores and scores of funds and we see it over and over again.
And when we talk to professional managers, it resonates. "Yeah, I have some concerns about my selling and I'm glad to be able to have a really thorough examination of just my selling. Because I know I can make it better." And it's they don't have in their organization feedback mechanisms to help them do it.
Lowlicht: Can I add something else in there that I've observed? Part of my business is to understand how people think because I have to guide them based on that. I think another reason people are better buyers than sellers is because when you buy, there's no tally to how you did. If you lose, it's a paper loss. "It's still a good company. It's going to come back." But when you finally sell something, if it goes higher, you sold too soon. If it goes lower, you made the right decision. If you outperformed, you did great. So, people like to be winners. People like to be right. That's why people argue. And when you buy, there is no weighing system as to whether you're right or wrong until the sale is made. So, it's much easier not to second guess a purchase.
And even if you bought Citigroup at $12, you can make a hundred excuses why you think it's going to $20. You still made the right decision. And right now, it's just a paper loss … But once you make a sale, your decision has been final and there's an accounting for the decision you made.
Ervolini: In behavioral finance, exactly what Marc's talking about is known as the disposition effect. And what we see repeatedly is that people love to take small gains off the table. We see it repeatedly, retail and institutional. People love to take gains for two reasons. Ten $1 gains make us feel better than one $10 gain. That's just the way our brains work. We like lots of small rewards as opposed to one big one. And once the gain starts to get up there, like $3-$4, we get fearful that the market will take it away. So, those two motivations cause us to take gains early.
And with losses it's what Marc was saying. As long as the loss is hanging in the portfolio, it has a chance of coming back. And we can postpone the self recrimination. But once you sell a position, that position is a loser forever and a little bit of you is a loser forever.
The other thing to keep in mind is that studies have shown that the emotional high we get from a dollar of win is only half the emotional low we get from losing a dollar. So a loss is twice as impactful as a win in money. We hate to lose and it's something primitive.
Forbes: Do investors really believe there is no reward without risk?
Ervolini: Oh, there's always a trade-off. When you allay someone's fears by changing their investment strategy, you're giving up return. And there's no way around that. The problem is the general investing public is misled into believing that return is magically created with no risk.
Lowlicht: And I think one of the problems is people want something for nothing almost. I don't know if that's the right terminology, but they have expectations of receiving, but don't consider what they give up. And they want to believe that there's a free lunch, that there's an easier way to do it. Or that somebody else has figured it out. Nobody else has figured it out. You've got a certain amount of return for the amount of risk you take. The more risk you take, the greater the return. The less risk you take, the less the return.
Ervolini: This is tough because one of the things we're not good at appreciating today is what a future outcome will feel like. And so, if Marc's interviewing me and he says to me, "Mike, can you handle a 5% draw down on your account?" I say, "Yeah, sure." And he says, "How about 10%?" I say, "Yeah, sure." And then he keeps going on and on. And he finally gets to a number where I say ouch. Let's say it's 40%. So now, based on his interview, Marc has a sense of one dimension of my risk tolerance. And then what happens is we're running down the road and my account gets drawn down 12% and I'm on the phone begging him to help me. Because I can't really appreciate what a 10% or 15% draw down feels like until I get there.
See More Intelligent Investing Features.
http://www.forbes.com/2009/03/04/psychology-selling-stocks-intelligent-investing_psychology.html
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