Donald Cassidy is a senior analyst with Lipper Inc., a Reuters company, doing research on money flows and closed-end investment funds. He conducts frequent seminars across the U.S.A., can be heard as a guest on radio talk shows, and has been quoted in The Financial Times , The Wall Street Journal , Barron's , Worth , Kiplinger's Personal Finance , The New York Times , and Smart Money . His book ' Trading on Volume ' was named 'Investment Book of the Year' by the 2002 Stock Trader 's Almanac.
Principle #1: Always force yourself to move toward discomfort!
Investment/trading success cannot come from actions that make you comfortable. Buying or holding when stocks are high (following the crowd because you cannot abide 'missing the action') is a comfort-seeking decision. Likewise, fearful selling in a collapsing and low market is moving toward the comfort of cash - again at just the wrong time. Good decisions involve thoughtful analysis including pro-and-con lists. When leaping in/out rapidly , you've thought of only one side and are moving to what is apparently obvious. The crowd , a few million in size , doing the same thing thus collectively is creating temporary maximum pressure and so a predictable price-reversal point. Hold and/or buy when it is scariest and sell when the majority celebrate their brilliant conquests. Right, contrarian actions are always lonely and very uncomfortable.
Principle #2: Avoid the losers' game of owning favorite stocks for the long term (a.k.a. Heresy #1).
Rapid and relentless change (technology, regulation, internationalization, competitors ' ascendancy) makes the odds of extended corporate dominance extremely low. In the five highly prosperous years 1996-2000, of more than 8,000 U.S. stocks, only 20(!) managed to avoid a single down quarter in earnings - a 99.8% failure rate. Companies rarely control the top of the hill for long; those situated there are priced very dearly. Holding them exposes your capital to sudden devastating loss at any sign of faltering momentum.
A tiny number of mutual fund managers compiles consistent above-average records. Their shares are worth holding while individual stocks of current corporate winners are at extreme statistical risk of obeying gravity. Xerox, Polaroid, Memorex, Digital Equipment, Sears, and AT&T are a few examples of the article-of-faith names of a generation ago. In the long term, there is no 'business as usual'.
Principle #3: Never buy a stock without simultaneously placing a sell order at your target.
Failing to have a target reveals fuzzy thinking. Your target should include all three of these: a price objective, driven by a scenario, in a specific time frame.
If your price is reached, or if the scenario does not play in the anticipated time, you must sell rather than rationalize. Don't buy stocks merely because you like the industry, respect management, or agree with their social goals. Require a driver that will push the stock higher - not those other nebulous 'reasons'. The object is profit, not good feelings!
Principle #4: Believe deeply in the 'cockroach theory' and act on it .
Like those lowly bugs , bad news for a company seldom appears solo; a first disappointment is very likely followed by others.With thousands of stocks available, why remain loyal to under-performers? Stocks are not insulted by your selling them! Move on to what is working rather than sticking with the sleeping dogs or bad ones.
Especially, stocks heavily owned by institutions take long periods to regain money managers' trust and to overcome overhanging stock held by those wishing they'd sold before bad news hit. The widely heralded 'dead-cat bounce' after a terrible fall is small and brief.
Principle #5: Untie that second hand from behind your back: become able to sell short! (Heresy #2)
I dearly wanted to list this first but feared most readers would quickly turn the page. Undoubtedly you've noticed that stocks both rise and fall. Then why be biased and seek profit in only one of two available directions? Shorting is not unpatriotic, morally wrong, or foolish - just an underutilized tool. Stocks get overpriced (fundamentally) and overbought (technically) exactly as many times as they're cheap and oversold - because prices move in waves, whose tops and bottoms are equal in number. Don't cut your opportunity to half the distance prices move. Would you fervently eschew a raincoat or umbrella because the weather is fair more days than not? Discard this self-imposed limitation!
Tactic #1: Always, always sell all large-cap and high-P/E stocks before earnings are due to be reported !
Good news is rewarded only slightly, but disappointment drives immediate, steep price declines. So holding literally stacks the payoff odds against you. Institutional ownership raises the size of selling deluges, as does a long record of prior successes.
Today's minimal commissions make stepping aside before the event very cheap insurance. Besides, learning to place sell orders readily is good practice that will make this unfamiliar activity seem more natural over time. Internet databases list expected EPS-report dates; phone the company to check.
Tactic #2: Be nimble , or the crowd will surely trample you!
Neither buying nor selling is a for-life decision; learn doing both as readily as ordering lunch when the situation requires. Instantaneous worldwide internet transmission of fact and opinion means the crowd takes virtually no time to move a stock's price. To avoid consensual victimhood, you must move rapidly. Investors/traders are paid well to anticipate change, but badly for reacting with the crowd after new facts arise. Companies change, so your opinion and position must. Today's price already reflects whatever you'll find in print or databases; you are not the first to see it!
Tactic #3: Gracefully and promptly accept unreasonable profits!
Draw a line from your buy price and date to your target price and time. When fortuitous news, a major brokerage recommendation, favorable media coverage, or market euphoria shoots a stock notably above that line, sell! Not doing so means you're now accepting a lower future return rate from today to your target
Think opportunity cost of capital. You can always buy back. When the buying crowd swells well beyond normal that condition is unsustainable, so the stock must retreat. Understanding that, why hold on? Constantly ask if you'd buy today what you're presently holding, at today's price. (Holding is buying again!) What you'd not buy, you should sell.
Tactic #4: Rid your decision process of ego's misguiding influences!
Overcome perfectionism: humans cannot always be right or routinely get the best price. Admitting mistakes early reduces money loss and ego pain. Resist temptations to 'demand your money back'. Too many investors refuse to sell unless they get back every cent paid (for what has proved not a great choice). Meanwhile, many opportunities elude those 'locked in'. Why demand getting back those last few percents in your proven laggard? Think opportunity cost, not blind loss aversion!
Forget three irrelevant facts: what you paid for the stock (the worst mental anchor), what it sold for at its all-time high (now proven a market mistake by subsequent evidence), and its high since your purchase (a strong but often wrong goal). Stocks over-run both up and down. A high was a temporary price error, not a deserved value.
Tactic #5: Watch the wider world for clues that a trend reversal is due.
Not all relevant information about markets is found in the Financial Times , The Times or The Wall Street Journal . Watch humor and advertisements (whose success requires wide, understanding consensus) for signs of a bubbly, overconfident societal mindset. Cartoons, TV sitcoms, and print and electronic-media ads reflect well-established (late) trends. Do jokes feature easy riches (time to sell), or instead people leaping from bridges and windows (panic, a bottom)? When auto and holiday-trip ads refer to our market gains, time has come to hit the exits!
