Habits to Invest By
Investing in the stock market is a mix of the proper psychology, philosophy, good habits, proper goals and the means to attain those goals. Adherence to some basic guidelines will enable you to position yourself in stocks in the early stages of up moves and alert you to get out of stocks prior to significant declines.
A knowledgeable trading instructor once said that there are four steps to becoming a good trader. That statement holds true for learning a new trading system or resource such as this one. First stage, unconscious incompetence - you don't know what you don't know. Second stage, conscious incompetence - you know that you don't know everything about the system and set about learning what you need to learn. Third stage, competence - you know how to use the trading system successfully but you have to think about it as you use it. Fourth stage, unconscious competence - you know how to use the system but you don't have to think about it much (but thinking is always recommended). Use of this site is designed to take you from stage one to stage three very quickly, and
it's free for thirty days.
In accordance with the
first quote listed above set high expectations for your portfolio performance. Achieving yearly gains that merely match the market or barely exceed it is just settling for "bones". Successful traders and investors beat the market. To do so they choose stocks that perform well in the time frames for which they are held. Day traders pick stocks that perform well intraday, swing traders pick stocks that perform well over the course of a few days, investors pick stocks that perform well over time.
The second and third quotes listed above require a longer explanation. Loss is a part of investing since no one chooses winners all the time. But smart investors can avoid unacceptable losses. What is an unacceptable loss, and how can it be avoided?
An unacceptable loss occurs when an investor holds a losing position beyond the point of optimum recovery. Every day some stocks will go up and some will go down. If on average an investor made a gain of 2.5% a day (which would be very good over the course of a year (+600%)) on some days there would be losses but the next day, or over a few days, there would be a recovery.
If bad news is released about a good company its stock price can be punished severely. If the price were to drop by 10% in a day how many days would it take for the average investor mentioned above to recover at 2.5% a day? Four days of 2.5% gains would equal a 10% gain but not a 10% recovery. That's because a 10% gain after a 10% loss would not bring the stock price back to its pre-loss value. It would take more than a 10% gain to recover and longer than four days at 2.5% a day (see table 1).
| (Table 1) |
|
|
|
|
Principal |
Gain |
Ending Balance |
| Loss Day |
$ 10.00 |
-10.0% |
$ 9.00 |
| Recovery Day 1 |
$ 9.00 |
2.5% |
$ 9.23 |
| Recovery Day 2 |
$ 9.23 |
2.5% |
$ 9.46 |
| Recovery Day 3 |
$ 9.46 |
2.5% |
$ 9.69 |
| Recovery Day 4 |
$ 9.69 |
2.5% |
$ 9.93 |
| Recovery Day 5 |
$ 9.93 |
2.5% |
$ 10.18 |
You never know how far a stock will drop before recovering but a smart investor will exit a losing position before a drop of 10%. In the scenario shown above an investor with a long position could limit loss (and therefore the recovery necessary) by selling as soon as the stock price lost 8% (see table 2).
| (Table 2) |
|
|
|
|
Principal |
Gain |
Ending Balance |
| Loss Day |
$ 10.00 |
-8.0% |
$ 9.20 |
| Recovery Day 1 |
$ 9.20 |
2.5% |
$ 9.43 |
| Recovery Day 2 |
$ 9.43 |
2.5% |
$ 9.67 |
| Recovery Day 3 |
$ 9.67 |
2.5% |
$ 9.91 |
| Recovery Day 4 |
$ 9.91 |
2.5% |
$ 10.16 |
As shown in table 2 if the loss was limited to only 8% then a greater amount of principal will be available to appreciate in value when the stock price recovers. Greater principal means greater gain amounts. Thus less days to recover will be required.
Bad news about a company can't always be anticipated but the damage from that news can always be minimized. This illustrates the second and third quotes shown above.