Avoid These 5 Financial Mistakes and Your Investments Will Thank You
By Mike Mc Mahon
If you’ve been investing for any length of time, you are no doubt aware of that monstrous, invisible hand that sometimes reaches into your investing account and snatches away money. It doesn’t seem to matter how many books you buy, how many seminars you attend or how many hours you spend analyzing price charts, sometimes it seems that you just can’t prevent The Hand from wreaking havoc on your investment account.
Whether you’re a seasoned professional or just thinking about opening your first investment account, your ability to stop The Hand is proportional to how well you understand and overcome its five sticky fingers: unrealistic expectations, a lack of methodology, a lack of discipline, a lack of patience and a lack of money management. These are the five fatal flaws of investing.
Fatal Flaw No. 1: Unrealistic Expectations
Between you and me, nothing makes me angrier than those commercials that say something like: ”$5,000 properly positioned in natural gas can give you returns of over $40,000.” Advertisements like these are a disservice to the financial industry and can end up costing uneducated investors a lot more than $5,000. They are the prime culprit behind unrealistic expectations, our first fatal flaw.
Yes, it’s possible to experience above-average returns from investing. But usually it also requires some above-average risks. So, just what is a realistic return to shoot for in your first year as an investor? Are you hoping for a 50, 100, maybe 200 percent return? As a new investor, your goal should be to match the S&P 500 return. The S&P has returned on average 7.6% over the last 50 years. If you can manage that, then in year two try to beat the Dow or the S&P. These goals may not be flashy, but they are realistic; and if you can achieve them and are satisfied with those results, you can fend off one finger of The Hand.
Fatal Flaw No. 2: Lack of Methodology
If you aim to be a consistently successful investor, then you must have a clear and concise way of looking at the markets. Without that vision, you fall victim to our second fatal flaw of investing: a lack of methodology. Guessing, or going with your gut instinct, just doesn’t work over the long run. If you don’t have a defined investing methodology, then you don’t have a way to know what constitutes a buy or sell signal. Even worse, you won’t be able to consistently identify trends.
How to overcome this fatal flaw? That’s easy: just write down your methodology. Define in writing what your analytical tools are, and, more importantly, how you plan to use them. It doesn’t matter whether you use the Wave Principle, point and figure charts, Stochastics, RSI or a combination method but it does matter that you make the effort to define your method. That means writing down what will constitute a buy or a sell for you, what your trailing stop is and exactly how you will exit a position. If you do not do it, it won’t be done and The Hand is forever in your pocket
Fatal Flaw No. 3: Lack of Discipline
Once you have clearly defined and identified your investing methodology, you must have the discipline to follow your system. A lack of discipline in this regard is fatal flaw number three. If the way you view a price chart or evaluate a potential trade setup is different from how you did it a month ago, then you have either not identified your methodology or lack the discipline to stick to your guns. The formula for successful trading is to be consistent with a proven methodology. Once you define one that works for you, follow it religiously.
Fatal Flaw No. 4: Lack of Patience
Our fourth fatal flaw of investing is lack of patience. I read somewhere that markets are in a trend only 20 percent of the time and, from my experience, I would say that’s about right. It means the other 80 percent of the time the markets aren’t trending in any one clear direction. Let that sink in for a moment.
That’s why I believe that over any given period there are only two or three potential good investing opportunities. For example, if you’re a long-term investor, you probably already realize that there are only two or three compelling tradable moves in a market during any given year. Likewise, if you’re a short-term investor, you’ve noticed that there are usually only two or three high-quality trade setups in any given week.
Because investing is inherently exciting (hey, anything involving money is exciting), it’s easy to feel like you’re missing out on the party if you’re not trading. But don’t worry, if you miss an opportunity today, there will be another one tomorrow, the next day, next week or next month. I promise. Four fingers down, one to go.
Fatal Flaw No. 5: Lack of Money Management
Our fifth and final fatal flaw of investing is lack of money management. This one deserves more than a couple of paragraphs because money management encompasses risk/reward analysis, probability of success and failure, protective stops and much more. Still, I want to address it with a focus on risk as a function of portfolio size.
The big boys--institutional investors--tend to limit their risk on any given position to 1-2 percent of their portfolio. If you apply the same rule, then for every $5,000 you have in your investing account you can risk only $50--$100 on any transaction. Stocks may be a little different, but a $50 stop in corn, which is one point, is simply too tight, especially when the 10-day average investing range in corn has lately been greater than 10 points. A more plausible stop in this case would be 5 or 10 points, depending on what percentage of your portfolio you are willing to risk. For that, you would need between $15,000 and $50,000 in your investing account.
Simply put, I believe many investors make the mistake of entering a market without the necessary funds or capital to support their choices. To overcome this fatal flaw and keep The Hand out of your pockets, I’ll refer to a line I love from the movie The Patriot with Mel Gibson, where one character explains to another how to shoot a rifle: “Aim small, miss small.” If you have a small investing account, then trade small. You can do that by investing in fewer shares or contracts or investing in e-mini contracts. Bottom line, realize that the key to becoming a successful investor is longevity. If your risk on any given position is relatively small, then you can afford to weather the rough spots. On the other hand, if you risk 25 percent of your portfolio on each trade, after four consecutive losses you’re out altogether.
Break The Hand’s Grip
Successful investing is not easy. It’s hard work--really hard work. If anyone tells you otherwise, run the other way, fast. But all that hard work can be immensely rewarding, with the possibility of above-average gains and the unmatched sense of satisfaction that you get after a few nice trades. To get to that point, however, you must first break all five fingers of The Hand.
About the Author
Mike Mc Mahon
Passion and enthusiasm are the "watch" words of Mike Mc Mahon. He brings both to his trading and his teaching, with hands-on experience in the market since 1977, as an investor, a trader and a licensed Commodities broker. Mike is one of the founders of Online Trading Academy and has recently retired after 13 years as its Director of Education in order to simply do what he loves best – trading and teaching.