Tuesday, May 15, 2012

Smaller Losses, Bigger Gains

Minimize Losses
I have said it before, and I am going to keep saying it.  I believe the single greatest advantage the personal investor has over fund managers is the ability to avoid taking big losses.  My favourite definition of insanity is when someone keeps doing the same thing over and over again, each time expecting a different result.  If we are losing money from our portfolio, we need to change what we are doing - quickly.  I know enough about human nature to understand the reasons it is difficult for most people to adopt such an approach, but it is not impossible to do, either.  Buy and Hold leaves far too great an amount of potential profits on the table for the personal investor.  At the same time it also exposes them to a vast array of expenses and fees at the hands of the financial institutions relative to what they receive in return.

The Nimble Approach
At the other end of the scale we can day-trade for quick, small profits.  For my money, options would seem better than stocks for such an approach.  Few people, though, have the knowledge and skill regarding options trading to actually do so.  The biggest options markets are also in U.S. dollars, so there are currency and tax implications to consider, as well.  So what is the regular personal investor to do?

Trend Watching
My best results have always come from following market trends.  Of course there are long-term trends, and very short-term trends.  Some are volatile, and others are as clear as a straight line on a chart.  But rather than trying to dictate what a trend should look like, I let the market show me.  Based on past trends in a particular equity and a particular market, I set realistic limits and cash in when the opportunity presents itself.  For instance, with a normal trend and a normal sized position in my own personal portfolio, if I make a profit of $1,000.00 on a single trade, I know to take the money and close out my position.  It isn't automatic, but I tolerate very little risk of giving the money back once I have reached that point.

Small Losses; Big Gains
It isn't like I always get the trend right, either.  In those cases, when a trend reverses, I have had to develop the discipline of exiting a position when it starts to lose money.  It has cost me a few wins, but it has also saved me a ton of losses.  Small losses and big gains are the keys to success.  There isn't a fund manager on the planet who can adopt this strategy simply because the amount of money they throw around is far too large.  That, my friend, is why Buy and Hold is the only thing you will ever hear about from the investment industry, backed up by countless academic studies funded by, guess who?

The Money Trail
On the latter point, I want to share that I just read a book in which the author points out that even many of the scientists believe we are chasing the wind when it comes to our theories on climate change.  It doesn't mean our actions are not having a negative affect on global climate.  What it really means is for a scientist to receive substantial funding in that field, their studies have to resemble the current thinking.  It is hard to find our lost keys in the dark if we only spend our time looking where there is a light shining.  Sadly, it is how the world works.  It is also how the Buy and Hold marketing strategy became the Buy and Hold investing strategy.  More on a profitable investing approach for the personal investor, later.

Do you find it difficult to avoid losses in your portfolio?


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