Stock moves are based on
fear and greed. Unfortunately,
basing buying
decisions on greed and
selling decisions on fear
leads to bad decisions. Buying greed
and selling fear leads to buying high
and selling low. It’s not just the
execution price that is the problem,
however. Being controlled by fear
and greed leads to bad money
management decisions.
Nearly all investors can state a
case where they were extremely
confident about a stock — and
whether it was based on a strong
technical or fundamental picture,
greed takes over and money management
decisions are ignored.
The stock may be at $10 and you
are certain that it will hit $20. As a
result, you load up on the stock with
a large portion of your assets.
Unfortunately, before hitting $20 the
stock falls to $7. You were right
about the move but wrong on the
timing. Because you had too much money invested, you couldn’t
stomach the drawdown and the
stock was sold for a loss.
The lesson to long-term success
is proper allocation of your assets.
In our example, if the investor had
not loaded up on the stock trade, he
could have ridden out the short-term
decline and enjoyed the benefits of
his correct projection.
Many traders lose everything in
the markets because they wager an
inappropriate percentage of their
trading capital on a single position.
Unfortunately, that single position
invariably turns out to be the worse
of all the holdings. When the trade
goes badly, the adverse effect is
crippling.
Staying
power is
important in
successful
trading. While
valuation,
trend direction,
and
timing are all
important,
proper position sizing is the most
critical. With proper position sizing
you can be wrong and play another
day. With bad position sizing, you’ll
end up with big losses and little
hope of recovery.
Instead of buying from greed,
treat every position like it could be a
loser. Yes,
there is
power in
positive
thinking but
overconfidence
leads to
bad results.
Recall that
80% of all
motorists think they are above
average behind the wheel. Shun
your pride and you will make better
decisions. Don’t attribute winning
positions to smarts and losing
positions to bad luck.
Having a positive attitude about
your trading system and your longterm
goals are important. However,
overconfidence in any single trade can cause you to mismanage it by
taking on an undue amount of risk.
If you believe every trade will be a
winner, the need to confirm that
belief may cause you to stay too long
in a trade that has moved against
you.
It may also prompt you to take a
position size that is simply too large.
Staying in a trade longer than you
should or having too much money at
risk is the surest road to disaster.