The Flaw In Our Emotions
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Finance > Personal Finance
Apr 18, 2007
The Flaw In Our Emotions
As humans we have a natural tendency to try and influence our surroundings and events we take part in. This is one reason as a species we have succeeded but it is also one of the fundamental flaws we all have when trying to achieve success as a trader. As traders we have to realize we have no control over the market and if we accept that then we have to accept that we can not influence the direction of the market. The problem of course is we have a tendency to try and succeed and when inevitable losses come it is easy to let those losses effect us emotionally. Becoming euphoric when you hit a winning streak is almost as detrimental as becoming depressed when you have a string of losses. We traders have to try to achieve a state of impartiality. We have to accept that we will have losses as readily as we will gains. Reaching a stage where you can comfortably accept losses, in the knowledge that your method of trading will produce profits in the longer term, is the state we have to aspire to. Trading is not an exact science. No matter what anyone tells you, trading is not, nor has it ever been, an exact science. Trading is an art. To date there has never been an institution or individual who can guarantee you will beat the market every time you trade. Just think about it, if anyone one had an exact method that always won, they would have all the money in the world, given enough time. Big institutions with all their expertise still only chug out 10% a year in a good year. Am I saying that you can't make money in the markets? Absolutely not. You can make money in the markets and quite often a lot more than the institutions. The point is, be wary of anyone telling you how great they are and how their method will make you rich. Would you sell something that made you rich? If someone is trying to sell you a system or method ask him or her for their audited accounts. Any trader with a half-decent track record will be more than happy to show you his records. One other reason some people don't make it in the trading game and probably the hardest for some people to own up to is, some people are just not meant to be traders. Just like we are all not meant to be doctors or priests some people are not cut out for trading. Once you finish this book take some time to ask yourself if this is really what you want to do. It might be a decision that could save you thousands of dollars. Here's the good news! Once mastered trading can be a rewarding profession both financially and emotionally. It can give the financial independence to never work for a boss again and you will learn a lot about yourself as a person on they way to becoming a trader. Even though you think you want to learn how to trade it is a good exercise to ask yourself if you are really an investor or speculator. An investor is someone who buys something in the belief that over the long term the security (any investment vehicle that can be traded) what ever it may be will go up in value. Their period of time may be months, years or even decades. They will be quite happy to own a security for a longer time period because they believe in what they have just bought or have researched the security and are happy that it will increase in value in the long term. An example of an investor is Warren Buffet, one of the most successful investors of all time. Commonly Referred To Sayings of Warren Buffett - Never invest in a business you cannot understand. - Risk can be greatly reduced by concentrating on only a few holdings. - Buy companies with strong histories of profitability and with a dominant business franchise. - You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. - Be fearful when others are greedy and greedy only when others are fearful. - Unless you can watch your stock holding decline by 50% without becoming panic-stricken, you should not be in the stock market. - It is optimism that is the enemy of the rational buyer. - The ability to say "no" is a tremendous advantage for an investor. - Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell. - Lethargy, bordering on sloth should remain the cornerstone of an investment style. - An investor should act as though he had a lifetime decision card with just twenty punches on it. - Wild swings in share prices have more to do with the "lemming- like" behavior of institutional investors than with the aggregate returns of the company they own. - As a group, lemmings have a rotten image, but no individual lemming has ever received bad press. - An investor needs to do very few things right as long as he or she avoids big mistakes. - Is management candid with the shareholders? - Do not take yearly results too seriously. Instead, focus on four or five-year averages. - Focus on return on equity, not earnings per share. - Look for companies with high profit margins. - Growth and value investing are joined at the hip. - It is more important to say "no" to an opportunity, than to say "yes". - Always invest for the long term. - Does the business have favorable long-term prospects? - It is not necessary to do extraordinary things to get extraordinary results. - Remember that the stock market is manic-depressive. - Buy a business, don't rent stocks. - Wide diversification is only required when investors do not understand what they are doing. - An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business. A speculator is someone who buys or sells something with no directional bias. He has no loyalty to the thing he is buying or selling and will typically own something from 1 minute to a few days or even weeks. An intraday trader may buy and sell a security a hundred times in both directions in the same day. An example of a speculator might be someone like George Soros. As a well-respected currency speculator, he once shorted the British Pound for one day and gained in excess of $1 billion. Although not totally responsible, Soros' comments on the Russian economy contributed to their stocks plunging 12% in the first hour of trading. Five days later the currency had devalued 25%. Its not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong. Now that you know the difference between Speculator and Investor only you can decide which one you are. If you intend to day trade the markets then you are a speculator. The question of whether you are an investor or speculator is a personal question of your own psychology. The good news is that our technical approach works for both types of character. Personally consider myself a speculator.
Martin Chandra is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to here.
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