Year after year I use the same basic principles and methods, just apply them in different ways to suit the current market conditions. One of the constants that never seems to change is human nature- how fear and greed guide the market action. Succumbing to either of these emotions often leads to financial loss. Here are 10 critical rules for investing that will help become a better investor and avoid these traps:
1. There is no one “right” way to trade
This may sound over simplified and a no brainer yet most people think there is one magic way to trade. FALSE! There are many ways to analyze markets/stocks and there is no one “right” answer. Take one that you like and test it until you have confidence that it works. Then apply it.
2. Write a Trading Plan
Success has a better chance of happening when you write down a plan to get there. Make your plan include your rules for entry and exit, risk tolerances and a process for review. Adapt your plan over time as you find better ways to achieve success.
3. Manage Risk
Understand the risk in every trade you make and don’t take risks that you cannot tolerate. If your exposure to loss is more than you are comfortable with you will inevitably break your discipline. I like to define my risk based on my overall portfolio. Not just from entry to exit.
4. Limit Losses
You should always know where the exit door is in case something goes wrong. Before I buy a stock I know exactly where I am going to exit (if wrong) and how much I’m going to risk (% of my portfolio). Pick your exits based on important areas where the market has proven your decision to enter wrong. If the stock falls to that price, get out. Don’t let small losses grow into big losses.
5. Take Responsibility for Your Decisions/Actions; Don’t Blame Others
There may be a good argument for why a loss you have suffered is someone else’s fault. The newsletter writer could have been wrong, the media could have been wrong, the government could have gone back on a promise, the company could be corrupt, etc, etc. …But blaming others will never get your money back or help you learn from your experience. You will not change the actions of others, you can only change your own. Therefore, blame yourself for everything that happens with your money and take steps to make it better.
6. Date Your Stocks; Don’t Marry Them. Stop Falling in Love
The more you know about a company, the more likely you are to ignore the market’s message. Companies want you to own their stock; the more investors that they get to own their stock, the higher the price goes. As a result, there is a bias to the information that you are exposed to. If you listen too much you may miss activity in the market that is telling you that something is wrong.
7. Profits Are A Function of Time; Practice Patience
8. See the Other Side of the Story
Everything you know about a stock may tell you to buy it and you may do so with complete commitment. But, always ask yourself, “Why is someone willing to sell to me at this price.” If you understand their motivations for selling versus your motivations for buying, you can better determine who is right. Without an understanding of the other side of the trade you can not determine whether the other side is wrong.
9. Avoid the Herd
The crowd usually loses. When buying, look around at your fellow buyers. Are they well informed, smart investors or are they generally uninformed people watching 60 Minutes? Always try to be one step ahead of the herd.
10. Post Analysis- Analyze Your Results
The market is always evolving, making constant evolution in your approach to the markets important. On a regular basis, analyze your trades and looks for patterns of self-destruction. Make changes as necessary. Create a trading journal of your own to help you do this.