Investors are a strange lot indeed. When I made my first fu- tures trade in the summer of 1968, I had no idea that there were as many different approaches to the markets as there were inves- tors and traders. I’ve also discovered that even though investors say they want to make money in the markets, their behavior often is just the opposite.
I’ve distilled some of my more important observations of in- vestor behavior into a few pages. I hope you enjoy them, but most of all, I hope you benefit from them. Here, then, in no particular order are my thoughts.
Investors are often too willing to take tips that have no history behind them, while they ignore solid trades with a long history of reliability. Investors often work hard to gather reliable informa- tion. They plan their investments, are methodical in setting a risk point, and have the discipline to follow their own research.
Yet, all it takes is one urgent call from a broker or one piece of dramatic news, and all their good intentions vanish. They melt into a pool of emotion, abandoning their discipline as they give way to fear and greed.
Investors all too often react impulsively to news, not knowing the odds of success, the risk involved, or the history behind the strategy they have planned. They lose money on the investment opportunity that they took impulsively, and yet they fail to learn from the experience. It seems that the human mind is always looking for an “easy shot.” When something comes along that seems easy, discipline appears to deteriorate in spite of all intel- ligent reasons and past experience to maintain it.
Investors tend to be a very insecure group of individuals when it comes to the implementation of their strategies. What is it that
causes investors to commit blunders? Is it lack of knowledge, lack of capital, or lack of a systematic approach? Yes, it can be one or all of these. What it all adds up to is this: Investors tend to wal- low in insecurity, no matter how good their research may be. Only the exceptional investor is totally immune to the errors that re- sult from insecurity. Having a solid investment approach, com- bined with a disciplined approach to implementation, can go a long way toward eliminating most investor insecurity.
Investors love forecasts. Forecasts tend to polarize a person’s thinking. They tend to restrict possibilities and give investors tun- nel vision. They create a mind-set that is not easily overcome.
Investors poorly execute buy and sell orders in stocks. Inves- tors frequently complain about their price fills. Although there is certainly an element of truth to the complaints, there is also the fact that the overwhelming majority of investors have no idea about how to place orders effectively, or which orders are most suited to their purpose. By merely using the right order at the right time, an investor can save thousands of dollars.
Investors don’t like “insiders.” An insideris an individual who, by virtue of his or her position in a company or otherwise, has knowledge about a pending development in the markets that may not yet be known to the general public. Because investors believe that such knowledge gives insiders an unfair advantage, they are universal in their dislike and mistrust of them. They ac- cuse them of virtually everything from stealing money to fixing prices. Insiders are just as fallible and human as are all investors.
The only difference is that they have more experience and know how to “milk” markets for the results they desire. Unfortunately, some of the investment scandals of the early 2000s have helped reinforce public suspicion and mistrust of insiders. Although it
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may very well be true that those trading with inside information are playing the game unfairly, it is also true that they are not di- rectly responsible for individual investor losses. Ultimately, each investor must evaluate a situation and then take action. Insiders do not force investors to buy or sell stocks or real estate.
Investors hate buying when prices are rising and selling when prices are declining. A costly lesson I’ve learned from over 30 years in the futures business is the value of buying on strength and selling on weakness. By this I mean that when prices have started an upward trend, the path of least resistance is to buy when prices decline. And when prices are declining, the path of least resistance is to sell when prices go up. Investing with the trend is the most reliable way of making money, whether in stocks, futures, real estate, or collectibles. In spite of the fact that investing with the trend is the more reliable way to make money, many investors shy away from this effective strategy, because they’re always afraid of buying too high or selling too low. The average investor is always trying to find a “deal.” Although this may work with a street vendor in a flea market, it’s not a winning strategy in the financial markets. Many of us have been told that we need to “buy low and sell high” in order to make money. The fact is that we can make money if we “buy high and sell higher.”
To put it simply, you can board a train that is unlikely to leave the station because it’s not in service; you can board a train that’s heading back into the garage for repair; or you can board a train whose engine is running as it readies to leave the station. Clearly, the best choice is the train that is ready to leave the station or, better yet, the train that is just pulling out of the station.
Investors hate taking losses—even small ones. This is no sur- prise to you, is it? This is by far one of the worsttraits of investors.
All too often those little losses, which were not taken when they
should have been, turn into account-devouring monsters that can make equity disappear in a matter of days. Many investors would rather allow a small loss of several hundred dollars to turn into a monster than admit to the small loss at the right time.
Investors love to blame everyone but themselves for their losses. Consider the many times you blamed your broker or the insiders for your losses. Most often, we tend to blame everyone but ourselves for losses, but the ultimate responsibility for our investments is our own.
Investors think too much and take too little action. Thinking is good in many aspects of life, even in investing; however, once you have determined your course of action based on your invest- ment approach, you need to take action. All too often, investors fall victim to an affliction called “analysis paralysis.” This mental condition expresses itself as the inability to take action due to an oversupply of information. Some investors allow themselves to become bogged down (i.e., paralyzed) by such a large amount of information that they cannot make a decision. This at times serves their purposes, as they avoid the possibility of losing money by not making a decision. Don’t think too much. This is not rocket sci- ence. Determine your course of action and then make your move.
Investors are inconsistent. At times an investor engages in a behavior or behaviors that are clearly in violation of effective in- vesting rules. Yet, in spite of the fact that rules have been broken, the investment results in a profit. This teaches the investor that consistent following of the rules is not necessary. But because the results of inconsistent rule breaking are random, the inves- tor will never know for certain whether breaking the rules will work or not. The inconsistency of results teaches the investor to react inconsistently.
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Investors can’t accept too many consecutive losses before they begin to doubt themselves as well as their investment methods.
The logic and experience of system testing tells us that some of the best investment methods are subject to considerable draw- downs as well as strings of losing investments. From my experi- ence, I’d have to say that taking as many as seven losses (even up to ten losses) in a row is not unusual. Yet, this is precisely what causes investors to abandon their method or to change mid- stream. In order to make a method work for you, you have to give it time and plenty of room. Most investors know this intu- itively rather than discursively.
Here is how you may embark or stay firmly on the road to consistent profits. First, examine your results by looking at your monthly brokerage statements. Attempt to determine why you made the investments you did. This will let you know at once whether your investments were systematic or whether they were based on a whim, emotion, tips, rumors, fear, or greed. If you’re like most investors, you’ll find that a relatively small percentage of your investments were the result of a system, and that most of your investments were prompted by other factors, most of which were totally unrelated to any definitive system, method, or indicator.
This will alert you to a problem area in your investing. It will let you know, without a doubt, that you are not basing your de- cisions on a consistent approach. The second step, then, is to fix this problem by looking for a method that has simple, unam- biguous rules of application.