Five Minute Investing: Know Yourself
As you have probably seen by now, the emotions and predispositions we are all imbued with tend to work against us in the world of aggressive investing. Often to succeed in this business we need to develop the ability to do exactly the opposite of what our emotions are telling us. To do this effectively, it is necessary to ferret out the real reasons why we are investing in the first place.
While "to make money" is likely the obvious reason, in reality there are myriad reasons why we try our hand at stocks. These range all the way from the money objective, to wanting to feel good about ourselves, to garnering the respect of others. These are at least as strong as the money factor, and when you think about it, money is usually the means for achieving something else - like respect, etc. Only misers want money alone. From a practical standpoint, we are all a mixture of these reasons and more. Therefore, if we are to succeed, it may be helpful to know what our own true motivations are. Whatever your reasons for wanting to succeed at stocks, you simply must learn to keep your ego in check because it is the one thing that will lead you to make the wrong moves.
I cannot psychoanalyze you, but I offer this chapter as a means for you to psychoanalyze yourself. My way of illustrating the motivations of investors will be to study the two basic types of investors. One of these is an extremely humble fellow, who does not care much about whether he is viewed as smart or ignorant by his acquaintances, but he does what he needs to do in order to optimize his investment results. The other is a proud person who cares primarily about his image in his own mind and in the minds of others. Swallowing his pride to increase his investment results is out of the question for him.
There is a little bit of both persons in each and every one of us. Before you embark on any investment approach it is best to search yourself to see which elements are present in yourself and attempt to root out the attributes of the ego-driven investor and bolster the characteristics of the results-oriented investor.
The Ego-Driven Investor
The ego-driven investor sees investing as something exciting. He mostly does it as a way to garner the admiration of others. He may also see it as entertainment. He is constantly talking about this or that great deal, imagining that others will stand in awe of his prowess and immense wisdom. In reality, he most likely does not really make too much money in the stock market, a fact which he hides from the outside world by any means possible.
Worst of all for the ego-driven type, he never gets any better at his investing. To admit he has been doing something wrong, even to himself, is more than his sensitive ego can take. Since the aura of being an investment wizard is simply a way for him to gain affirmation from others, he really doesn't care too much whether the results are there as long as he can still stay in the game and keep talking about his smart deals at cocktail parties. Of course, he conveniently forgets the bad ones and keeps turning over in his mind his best deals and how smart he must be. He certainly never does a post-mortem on any of his losing trades to figure out just why they were losers. He simply blames the loss on his broker, the company's management, or stock manipulators. He can't ask anyone what he may have done wrong, since to admit he's made a mistake to someone else goes directly against the grain of his objectives - to appear wise to others.
One way in which our friend Mr. Ego deals with losses is by stubbornly holding on to his losing trades, no matter how bad they get. He reasons that until he sells, he hasn't really lost anything, so why sell? Never mind that his broker sends him statements every month telling him that his account value has dwindled - he really has lost money -whether or not he admits it or not. In this way he assures himself that he can never really redeploy what's left of his capital into something more promising.
The ego-driven investor doesn't enjoy buying a stock that has already doubled in value, even if it could increase another 1,000% from there. The idea that someone else was "smarter" than him and bought at a lower price is more than he can bear thinking about. On the other hand, he dearly loves to buy stocks that are in a downtrend because there is a chance that he will be the one who will buy the stock at its low for the year. Imagine what bragging rights that would give him! Of course, most of the time he buys these types of stocks and they just keep going down, down, down. But that's OK, as these deals are unknown to anyone in his circle of friends. The prospect of that unlikely but alluring "buying the bottom" scenario keeps him coming back for more - losses, that is.
Even when he does get lucky and happens to stumble into a winner, Mr. Ego is his own worst enemy. He waits until the stock hits a new high for the year and then promptly sells out to lock in his profit. Of course, this stock was in an uptrend and keeps right on sailing far above where he exited. That's OK by Mr. Ego, though: he now has a profit that can be exaggerated the next time he sees his friends. Will they ever be impressed!
Thus, the ego-driven investor's strategy is complete: he always holds onto his losing stocks and when something starts to go right, he bails out faithfully. He has plenty to talk about at parties, but there is no way he can ever make a decent profit. The real tragedy is owed to the fact that since he blames others for all of his problems, he will never get any better.
The Results-Oriented Investor
The results-oriented investor seldom talks with others about his investment results. Really, he is too busy trying to make his results better. He is never too proud to buy a stock that is making new highs, realizing that those who are buying the stock most likely know far more than he does - and a winning company is more likely to keep on winning than a losing company is. The fact that someone else was smarter and bought at a lower price does not worry him; it is against his nature even to have such a thought occur to him. He is far too focused on trying to pick stocks that are performing well to entertain these types of thoughts. He compares his performance against others' performance only as a means of learning and getting better.
Five Minute Investing: Stock Picking
When the results-oriented investor finds himself with a stock that is zooming ahead, he holds on, letting the stock continue to do well for him. Conversely, when a stock stumbles badly enough that his predetermined plan says it is time to exit, he acts in an unhesitating manner. He follows his plan for buying and selling whether that means selling at a gain or at a loss. He also never sells a stock as it is making a new high, since his concern is not in selling the top but rather in letting his winning positions run their course. He does not mind selling a stock after it has retreated 50% in value, if being patient through price corrections is what allows him to capture the occasional 1000% gain.
One big difference between the results-oriented investor and the egoist is what he does with losses. While Mr. Ego blames others and learns nothing, the results-oriented chap studies in great detail how his loss occurred, and eventually figures out the fallacies in his thinking and/or system. Therefore he always gets better and better at what he is doing. He even keeps a notebook on each loss and records what he could have done better.
Don't forget why you are investing: To make money. If you have any other reason for investing, find another pastime. (For more on this, see Lessons From A Trader's Diary and Get Organized With An Investment Analysis Form.)
Five Minute Investing is Copyright © 1995 by Braden Glett,
who has given written consent to distribute on Investopedia.com. Check out Braden Glett's new book - Stock Market Stratagem: Loss Control and Portfolio
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