Individuals are consistently promised that investing in the financial markets is the only way to financial success. After all, it's so easy. Financial pundits across the country state the one simply buys a basket of mutual funds and they will make 8, 10 or 12% a year.
On a nominal basis, it is true that if one bought an index and held it for 20-years, they would have made money. Unfortunately, for most, it has not worked out that way.
Why? Because no matter how resolute people think they are about buying and holding, they usually fall into the same emotional pattern of buying high and selling low. Investors are human beings. Human beings naturally want to be in the winning camp when markets are rising and seek to avoid pain when markets are falling.
As Sy Harding says in his excellent book “Riding The Bear,” while people may promise themselves at the top of bull markets that this time they'll behave differently:
“no such creature as a buy and hold investor ever emerged from the other side of the subsequent bear market.”
Statistics compiled by Ned Davis Research back up Harding's assertion. Every time the market declines more than 10% (and “real” bear markets don't even officially begin until the decline is 20%), mutual funds experience net outflows of investor money. Fear is a stronger emotion than greed.
The research shows that It doesn't matter if the bear market lasts less than 3 months (like the 1990 bear) or less than 3 days (like the 1987 bear). People will still sell out, usually at the very bottom, and almost always at a loss.
The only way to avoid the “buy high/sell low” syndrome – is to avoid owning stocks during bear markets. If you try to ride a bear market out, odds are you'll fail.
And if you believe that we are in a new era where Central Bankers have eliminated bear market cycles, your next of kin will have my sympathies.
Let's look at some of the more common trading mistakes to which people are prone. Over the years, I've committed every sin on the list at least once and still do on occasion. Why? Because I am human too.
1) Refusing To Take A Loss – Until The Loss Takes You.
When you buy a stock it should be with the expectation that it will go up – otherwise, why would you buy it?. If it goes down instead, you've made a mistake in your analysis. Either you're early, or just plain wrong. It amounts to the same thing.
There is no shame in being wrong, only in STAYING wrong.
This goes to the heart of the familiar adage: “let winners run, cut losers short.”
Nothing will eat into your performance more than carrying a bunch of dogs and their attendant fleas, both in terms of actual losses and in dead, or under performing, money.
2) The Unrealized Loss
From whence came the idiotic notion that a loss “on paper” isn't a “real” loss until you actually sell the stock? Or that a profit isn't a profit until the stock is sold and the money is in the bank? Nonsense!
Your portfolio is worth whatever you can sell it for, at the market, right at this moment. No more. No less.
People are reluctant to sell a loser for a variety of reasons. For some, it's an ego/pride thing, an inability to admit they've made a mistake. That is false pride, and it's faulty thinking. Your refusal to acknowledge a loss doesn't make it any less real. Hoping and waiting for a loser to come back and save your fragile pride is just plain stupid.
