I Share The Most Important Lessons Learned From My Years Managing Money.
The investment process is difficult and enormously complex, which was part of the appeal that led me to money management and to now publish the Global Investment Letter. I thought it might be helpful to others to offer some observations to make the task a little easier, based on my study and decades of experience. The “rules” presented apply to both trading and investment, as I find it at times difficult to separate the two, as even the longest investment starts and ends with a trade.
1) INVEST/TRADE TO MATCH YOUR PERSONALITY
Everyone has their unique attitude towards risk and volatility. Invest and trade in investment vehicles that reflect your temperament. I have long maintained that people are more risk-averse than they think they are. Assuming more risk than you’re comfortable with is stressful and emotionally destabilizing, which leads to poor decision making. There is an old saying,
“if you don’t know who you are the markets is an expensive place to find out.”
2) BE AWARE OF HUMAN PSYCHOLOGY
It is crucial to be aware of psychology, both your own and others. Your psychology is your greatest obstacle to successful investing or success in most endeavours, for that matter. It is important to be conscious of your state of mind; are you feeling fearful, greedy, overconfident, etc.? It is especially worthwhile to monitor your psychology versus that of the general public. Investment success often lies in acting counter to the crowd, which is psychologically very difficult.
The value of reading should be apparent to any educated person, but what you read is as important as the act itself. Beyond books written specifically on investing, it is important to accumulate general knowledge with which to put events in their proper context. Reading history is very important. There is indeed nothing new under the sun, and knowledge of history can make current events much more understandable. I have read two books, in particular, this year that I heartily recommend. Lawrence in Arabia by Scott Anderson is an account of great power maneuvering in the Middle East in the 1910s. It does much to explain the intractable problems faced by the region today. The other recommended book is The War That Ended Peace by Margaret Macmillan. It is an account of geopolitics in the decades before WWI. It is wonderfully written and has many echoes of our current time.
To be a good investor, you must read widely. Books, magazines, the internet all can provide either specific investment ideas or information that will allow you to assess an investment. The best investors love to learn and are curious about the world.
4) REDUCE POSITION SIZE
Position size and diversification are basic risk control tactics. Smaller position size reduces volatility and potential losses on individual positions. Trading smaller amounts also tend to reduce potential stress and anxiety, which can be emotionally destabilizing and lead to poorer results.
5) DON’T TRADE AROUND EARNINGS ANNOUNCEMENTS
The markets can severely punish the share prices of companies that miss their earnings estimates by even a slight amount. It is best to avoid initiating or adding to positions ahead of earnings announcements. Similarly, if one is thinking of selling a position, it is advisable to do so ahead of an announcement.
6) INVEST/TRADE ONLY WHEN THERE IS A SOUND REASON TO DO SO
There is a natural tendency, among both amateurs and professionals, to establish positions to be “in the game.” The result is overtrading, or the assumption of marginal or poor-quality positions. Investment results will improve if one can maintain the discipline to limit participation to situations that have compelling risk/reward.
7) PERFECTION IS IMPOSSIBLE: INVEST/TRADE WITH THE ODDS
As human beings, we are fallible, so mistakes are inevitable. As well, even if your analysis is perfect, adverse results can occur through events beyond your control. Since nothing is certain, incorporating probability analysis into your investment process will help to keep the odds in your favour.
8) TRADE WITH A PLAN
Before an investment is made, the investor should have a clear understanding of why the investment is being made, why the current price is favourable, at what price the position will be sold if the trade goes bad, and at what price the investment will be sold if the position is profitable. Of course, once the trade is established, the various parameters must be adjusted in response to new information.
9) TRADE WITH THE TREND
There is an adage, “the trend is your friend,” It is very important to identify the prevailing trend and trade in the direction of that trend. Positions should be established or added to on pullbacks against the major trend.
10) CUT LOSSES AND LET PROFITS RUN
Human psychology tends to encourage investors to both hold on to losing positions in the hopes of recouping the losses and taking quick small profits when they present themselves. This is the absolute opposite of what should be done for profitable investment. Establish a maximum loss you are prepared to take on a position and stick to it. If a position is profitable, it should be held until a reason to sell presents itself, not because it has appreciated an arbitrary amount.
11) RECOGNIZE THAT ALL MARKETS ARE CONNECTED IS CONNECTED
It is important to appreciate that everything is interconnected. Monetary policy must be considered because it influences markets. The commodity markets should be followed, not only because commodity prices influence specific investments, but because of the informational content they provide about the world economy. Investors no longer have the luxury, if they ever did, of just contemplating their domestic market. It is important to be aware of foreign markets, current events, and geopolitics, now more than ever.
These concepts have stood the test of time and have certainly boosted my investment results while reducing risk exposure.
They provide a solid foundation for any investor/trader. I hope you derive as much value from them as I have.