What you know intellectually about stocks… bonds… mutual funds… commodities… real estate… or any other investment product isn’t worth a hill of beans when compared with your ability and willingness to respond rationally to the ever-changing perception of the market.
How you react (your personal behavior) to the behavior of the market as a whole will determine the degree of success you have with your investments.
More than likely, you know that you have to accept some risk when learning how to invest. But, what may not be as evident is that even the riskiest investment can be controlled.
Let’s use the technology crash (2000-2002) as an example. Investors were mesmerized by the extraordinary increase in stock prices from 1998 to early 2000.
Everything techie seemed to be making money. It appeared to the casual and the experienced investor that there was no end in sight for profit. But, without having a predetermined defensive plan that would automatically protect them in a down market… most of these investors suffered dearly.
Was this due to lack of awareness… hypnotic spell… greed… wishful thinking? Or, maybe a little bit of each.
It doesn’t matter. People who thought they knew how to invest just sat and stared as the value of their stocks soared skyward.
And, they kept sitting there even when the markets reversed course and plummeted into a dark hole.
Fortunes were made… and abruptly lost… because people who had yet to master the basics of how to invest believed foolishly that the downward spiral would stop.
But… it didn’t!
Although 2003 showed some improvement, it was too weak. And, both 2004 qnd 2005 were uneventful.
So… was it wrong to invest in technology stocks? Of course not.
But, it was wrong to commit money without first understanding how to invest using a predetermined course of action to protect your profits and limit your losses.
The Number One Rule… Don’t Lose Money Needlessly!
For instance, if a share price goes from $10 to $20, you should commit to sell if the price slides back to $15.
In other words, if the price gives back 25% of its gain… then, it’s time to sell.
No exceptions!
In this example, you would make 50 percent instead of 100 percent. This assumes, of course, you would have sold when the price grew 100 percent.
The fact is most investors would not really do this… that is, sell at that time.
Instead, they would get a little greedy because most people want more rather than settle for a reasonable profit.
This may be considered human nature… but it usually leads to unnecessary losses. The frightening downward trend of the stock market over the last 18 months simply proves that taking profits during times of decline can be the difference between preserving capital… of watching it go down a rat hole.
The point of all this is to remind us that our behavior is seldom… if ever… rational when dealing with investments.
For those investors who had only experienced rising markets… corrections were disastrous. Although market cycles can be somewhat predictable… the broad movements tend to be reactionary.
Having said this… even the current devastation was predictable… if only the average investor had followed the rule of stop-loss protection.
