It’s the beginning of the year. Traditionally, we resolve to do better each year.
Many resolutions are mundane promises to eat better, lose weight or save more money. Those are all important to do. But you should also resolve to make the most of your stock portfolio.
When Dr. Richard Thaler won the Nobel Prize in Economics last year, articles focused on his work to boost savings.
Thaler advocates enrolling employees into retirement plans by default. He found by making employees do something to opt out, like complete a form, most people simply do nothing and save for retirement.
Doing nothing is a powerful concept in growing wealth. It can even help you grow your wealth in 2018.
Trading and The Roller Coaster of Emotions
Resolve to do nothing for six months.
This year, resolve to trade your plan. Do nothing unless it’s part of your plan. That means first you need to plan.
Plan for the worst. Assume there will be a bear market. How would you trade that market?
For many investors, a long/short strategy might be best. This is a strategy that goes long buying stocks or call options to benefit from uptrends. The strategy also goes short, usually by buying put options, to benefit from downtrends.
Also, resolve to only accept as much risk as you truly can endure. If you take on too much risk, you won’t focus on the gains. Your emotions will follow the roller coaster pattern shown below.
Research shows investors act predictable when they get on that roller coaster of emotions. They buy in a state of exuberance at the top. They give up and abandon their plans in a state of despondency at the bottom.
How can you avoid the roller coaster of emotions?
Think like a trader with your trading account. Many traders think like long-term investors. This is bad.
Long-term investors add to losing positions. They rationalize losses.
They might think of stock dividends as a silver lining when a position shows a loss. Or they hold losers because they tell themselves it’s only a paper loss until they sell.
These are dangerous thoughts that destroy wealth for traders. Adding to losers can mean not having enough money to take the next trade signals.
Dividends aren’t a silver lining because they are usually so small they don’t grow wealth in the short term.
Dividends can add up over years. They are an accident of trading. If you get a dividend payment, that’s a bonus, but it won’t ever turn a short-term loss into a gain.
There’s no such thing as a paper loss. Losses are real for traders because their broker calculates their account balance including all gains and losses every day. They can’t ignore losses if the focus is on making money.
The truth is even long-term investors should cut their losses. Instead, they often wait to break even because they don’t want to admit they were wrong.
While waiting to break even, they often pass up extraordinary opportunities. Unfortunately, long-term investors will never understand the concept of opportunity cost.
Opportunity cost is the cost of what you miss while waiting for something else to happen. Traders have to minimize opportunity costs. They gladly sell one position when a better trading opportunity develops.
How to Trade Stocks Like Batting Champions
Finally, make a resolution to focus on your portfolio instead of individual trades.
Baseball players measure success with their batting average over the course of the season. They know they will fail to reach base 60% of the time or more. But each turn at bat is a new opportunity to succeed.
At the end of the season, in salary negotiations, they usually point to their batting average rather than highlight any one of the 1,458 innings of a full season. They know the money is in the performance of their portfolio (batting average) rather than any individual trade (inning).
You can do the same.
As a trader, focus on growing wealth. Don’t dwell on individual trades. That goes for winners or losers. Focus on open trades and trades you’re considering opening.
Your Trading Resolutions for 2018
These are simple ideas. But few individuals apply these ideas. That could explain why few individuals succeed at trading.
So, right now, create your plan. Then stick to your plan for the next six months. Decide then whether to change anything, and then stick with that for another six months.
Join the winners by thinking like a batting champion. Focus on what’s happening today rather than mourning or celebrating what happened yesterday.
You can increase your wealth in 2018, whether it’s a bull market or a bear market, simply by avoiding that deadly emotional roller coaster.
Michael Carr, CMT
Editor, Peak Velocity Trader