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About EHW
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Seven Helpful Tips to Improve Investment Performance By Edward Wong Once upon a time just a few years ago, if you were at dinner with your date and talked about the Federal Reserve Bank increasing the fed funds rate by 50 basis points, you would not get to second base. Now the chances are that your date would not miss a beat and ask you whether you thought that 50 "bips" (one basis points equals 0.01 percent) were not already discounted into the market and wonder whether she should adjust her portfolio. The greatest bull market in history has brought the once arcane pursuit of trading into the forefront of American consciousness and it has become commonplace to hear stock tips and macroeconomics discussed over Sunday brunch. In recent years, some have made more in their stock portfolios than they have at their jobs. Lured by the euphoria of instant wealth creation, many Americans have become part-time stock traders and some have even quit their jobs to become full time day traders. If you are thinking of taking a more active role in managing your money, take to heart a few time-tested lessons of seasoned traders. It could save you a great deal of heartache and money. Trading is a performing art and a process of self-discovery. It is a world of fast action and split second decisions and there are many ways to do it. That's why traders love the guidance of pithy rules, affirmations, and witticisms. Keep your losses small but let your profits run. The trend is your friend. Don't over trade. You'll never go broke taking profits. Don't let a profit become a loss. Bulls and bears both make money but pigs will always lose. The list goes on. Having rules and discipline makes sense but you'll discover very quickly that there are too many rules and they contradict. After many years of trading and talking to traders, I have found seven bits of advice that most seasoned traders would agree on. These rules offer guidance on trading process, not specifically on how to trade. 1. Understand how you feel about
risk Understand how you feel about risk. Investing is about risk. Because the bull market has been so strong and has lasted so long, some may have forgotten that you can lose money by buying stocks. Unless you are content with the returns of the US government money markets, short-term risk free investments, you will have to bear the risk of loss. So before you plunge ahead and pour your life savings into AOL, ask yourself how you feel about seeing your account drop by 30 percent. When you understand how you feel about risk, you will perform better in volatile markets. Have a plan. Plan your trade; trade your plan. In your plan, you should articulate your investment objectives, identify in what you would like to invest, decide how much you want to invest, and determine the level of activity to which you are willing to commit. Investments have different return and risk characteristics. Your plan should be consistent with the level of active involvement you want to commit and your tolerance for risk. If you cannot spend the time to make your own decisions about what to buy and sell, you would do best to invest your money in mutual funds and avoid individual stocks. If you are averse to risk, do not expect a 40 percent return. On the other hand, if you enjoy the thrill of risk and want to apply a great deal of leverage (borrowed money) in your account, options and futures and even options on futures might be the right vehicle for you. There is a good chance that if you put your money in very risky investments you may not enjoy the reward of high returns. 90 percent of futures accounts are wiped out within the first year. Do your homework. Trading is a game of details and every mistake you make can cost you money. It takes homework to make informed decisions about what you want to invest in and how best to do it. The more specialized and sophisticated your choice of investment is, the more homework you will probably have to do. Think about the things you would have to research to bet in the futures markets that the price of cotton is likely to rise over the next six months because you believe that the economies of China, India, and Egypt are at the right stage and that cotton inventories have been drawn down. Of course, you might want to buy Home Depot stock because you just came from one of their stores and were impressed by the crowds and the range of merchandise offered. Still, some homework could only help. Read, read, read -- everything you need to know is in a book or on the internet. Have a forecast. Fundamental analysis and technical analysis are the two ways that most professional investors and traders arrive at a forecast. Beyond that there are hot tips, brokers, personal experience, astrology and gut feeling. When all is said and done the only thing that matters is whether what you bought went up or what you sold went down. To act with resolve, you must somehow arrive at a point of view about the price of what you are considering as an investment. Where some investors go wrong is that they are incomplete in their forecast. A forecast should include price direction, duration and pace of price movement, exit price target, and bail out price target. So even if you are buying a stock because of a gut feeling or a hot tip, if you do your homework before you buy and decide the upside target and how far the stock would have to decline to prove you wrong, you will do fine. If you buy, all contingencies are covered. If it goes nowhere, you've lost only the opportunity cost of the use of the money. If it goes up, you are right. If it goes down to the price where you have decided to bail, then you have lost what you decided the bet was worth. Understand trading and investing timeframes. Timeframes can be sorted out into three: trading, speculating, and investing. Traders are in and out of markets very quickly, sometimes within minutes. Speculators seek to profit from price swings that could last from one day to several months. Investors buy for the long-term to benefit from price appreciation over a long period of time, often years. Traders like the wheat pit traders on the Chicago Board of Trade are in and out of hundreds of trades each day. Investors like Warren Buffet will buy a large quantity of a company's stock and hold it for many years. Understanding what your investment time frame is helps you to make decisions about when to enter and exit positions. If you are a long-term investor, do not make trades on the basis of short-term price fluctuations or you might find yourself out of an investment you really wanted to stick with. On the other hand, if you are making a short-term trading bet and you do not exit your position, you may be unintentionally holding a losing investment for a long time. Make specific bets. Making specific bets will give you clarity, resolve, and save you money. A specific bet will give you guidance in all market conditions. Buy $2000 of IBM any time it dips ten percent in price and buy another $1000 if it dips another 15 percent and hold until retirement is a specific bet. If the stock drops to lose half of its value, that bet tells you to hold. Whether you are right or wrong, you are guided and resolved. You may change your mind and decide to bail, but the original bet guides you to hold. If IBM shoots up and gains 20 percent on a news event, you may be tempted to sell, but your bet guides you to hold. Buy IBM because it is a good company is not a specific bet. If the stock experiences volatile fluctuations, your decision to sell, buy more, or hold will be subject to your mood, emotions, what others tell you, and any number of unknowable factors. The outcome of your investment will not be a result of your plan and your success and failure with it will be mere accident. Master your emotions. Greed, fear, frustration, and panic are the four powerful emotions in investing. Making or losing large sums of money is very emotional. You cannot control the markets but you can control yourself. How many stories have you heard about people buying at the highest price only to have a stock turn around and drop abruptly? Or of people selling a stock after seeing it drop twenty points in one day only to see it reverse and close unchanged? It is hard not to act on greed, fear and panic but if you have a plan and make specific bets, you are more likely to act with a clear head and purpose. If you do your homework, whether you win or lose, you are likely to have more fun and fewer regrets. Hard work and brains contribute, but luck plays a heavy hand. When you are making a three hundred percent returns on a stock, it may have started with work and brains but luck has surely blessed you. Warren Buffet has always said that he would rather be lucky than smart. While these tidbits of investor and trader wisdom cannot improve your luck, they can help you to assemble an investment approach that will put you in the markets with a constructive frame of mind. During a particularly volatile market week, I asked one trader what he feared and he told me his greatest fear was not being in the market because then it would be certain that he would make no money. He went on to say that he is constantly working, looking at 15 to 20 possible trades. Somewhere in there, regardless of the market condition, he would find a good bet. His process gave him clarity, resolve and confidence, a stable foundation from which to trade. His account, by the way, has out performed the S&P 500 for four years running. Ed Wong is an entrepreneur, investor, management consultant and freelance writer. He divides his time between New York and Hawaii. |
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