If you're going to keep one New Year's resolution, let it be that you will be a disciplined investor. That way you will harvest all of the market's bounty you're entitled to.
Every year around this time we make promises to ourselves or our loved ones — that, despite our best intentions, are difficult to keep.
We start sneaking chocolate around Jan. 15. We stop going to the gym around Feb. 1. And you can kiss that resolution to get rid of all of your junk the first time there’s a Chuck Norris marathon on TBS.
And despite traders’ and investors’ best intentions to change their behaviors, like Talking Heads sing in “Once in a Lifetime,” “Same as it ever was. Same as it ever was. Same as it ever was. Same as it ever was…”
Here are three predictions on how investors are going to continue to hurt themselves in 2014.
Investors get burned trading with emotion
The reason we don’t keep our resolutions is usually that our emotions get in the way. There is an emotional attachment to that slice of cake or those boxes from our high school days that clutter up the garage.
Trailing stops remove the emotion from the trading decision. You set your stop based on non-emotional criteria. The Oxford Club recommends a 25% trailing stop. That means that if a stock ever drops 25% from its high (after you’ve bought it), you exit the position.
That way, as the stock climbs, your stop rises with it until the point where a winner can’t become a loser.
You also won’t lose more than 1% of your portfolio if you’re sticking with your stops and with The Oxford Club’s recommendation of putting no more than 4% of your capital into any one position.
But the best part of using a trailing stop? The decision to sell is made when you buy, when you’re logical, not when you are trying to rationalize why you should hang on to a dog.
Investors will overtrade
After the market gained roughly 30% in 2013 and nearly 180% since the lows of 2009, investors who sat some of the action out feel like they need to play catch-up.
And there are lots of good ideas out there. Value ideas, dividend plays, momentum stocks, exciting speculative biotech stocks.
But you shouldn’t chase every idea. There are too many to trade effectively. You should trade only the number of positions you can comfortably monitor.
Overtrading can be expensive, too. Not only could you be getting out too soon, but trading comes with costs — commissions and taxes on capital gains.
Investors will panic when stocks correct
At some point, stocks will reverse. Probably after investors who have been on the sidelines for years have put their money to work.
When that happens, they’ll envision 2008 all over again and likely bail quickly, refusing to experience the pain of a few years ago again.
If you have a clear reason for getting into a stock — and more importantly for getting out — you can avoid this mistake. Whether it’s a stop, a piece of fundamental news or a technical level, you should have a clear plan for entering and exiting positions.
If the trade is being made for fundamental reasons, let the story play out. Don’t panic at the first sign of a correction. Exit the position if a stop is hit or if the fundamentals of the company change.
As Warren Buffett famously said, be greedy when others are fearful. A meaningful correction — which could be worsened by panic selling from these recent investors — should make for an excellent buying opportunity.
Furthermore, meaningful gains are made in the market when investments are held for years. Just ask anyone who has owned shares of McDonald’s Corp. (NYSE: MCD) over the past 10 years. They’re sitting on gains of 292%, or 416% if they reinvested the dividends. And shareholders of Colgate-Palmolive Co. (NYSE: CL) are up 162%, or 232% with dividends reinvested.
So in other words, investors will behave as they always have. Some things never change. And fortunately, that creates opportunities for other investors who remain disciplined.
If you’re going to keep one New Year’s resolution, let it be that you will be a disciplined investor. That way you will harvest all of the market’s bounty you’re entitled to, which you can spend on gym memberships for years.
I hope you have a terrific new year and that 2014 is filled with prosperity, health and laughter.
Marc Lichtenfeld is a senior analyst at Investment U. See more articles by Marc here.
The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.