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Tuesday, May 19, 2009

Slay the Dragon Within: And Win

Slay the Dragon Within: And Win

A Special Report


Wall Street Sector Selector


Recent market meltdowns and subsequent rebounds exposed the roles of greed and fear, the herd mentality and human psychology in global stock market action.

Successful investors understand their "humanness" and how to get their emotions to work for them instead of against them.

Greed, Fear and the Herd

Everyone has heard about greed and fear being the two primary driving forces behind investor decisions. And that is true because, while much has been written about markets being rational and investors making rational decisions based on earnings reports, price earnings ratios or technical analysis, the fact is that markets are not rational, as witnessed most recently in 2008's massive selloffs.

Greed and fear were at work.

And this has been seen time and again throughout history.

The Dutch had their tulips, Sir Isaac Newton was wiped out in the South Sea Trading
Company's meltdown in 1720, and we've had our own Black Monday in 1987 and the boom and bust just a few short years ago.

Greed is simple to understand. People want to make money. But fear is a little more complex in that there are really two types of fear: fear of loss, which we all understand, but also, fear of being left behind.

I believe a key to investment success is learning to control both your greed and your fear, and the solutions are the same for both.

Investors Who Slay the Dragon:

* Don't overtrade. In the search for better results or to limit loss, investors tend to overtrade and so wind up paying too much in commissions or getting whipsawed by short term gyrations of the market.

* Don't take too much risk. Greed causes investors to take too much risk, either through options, leverage or investing in risky companies or by taking positions that are too large to be comfortable.

* Don't go back and look at trades they have sold to see how they "would've done." When a trade is over, it's over. They don't do postmortems to see if they were "right" or 'wrong" about the market.

* Don't sell their winners too soon, unlike most investors who do this and miss out on further gains.

* Don't hang on to their losers too long. Most investors find it's hard to admit they were "wrong" and so lose more than they should or could.
Ego plays a big role here. People want to be right, but "hang on, it'll come back" is not an investment strategy. Just ask anyone who still owns some of the darlings of the boom and bust.

* Don't do daily mental accounting of how they're doing. They see t heir whole portfolio, not just the rise and fall of individual positions, and they don't keep a score card of their gains/losses. A once per month review is plenty.

* Don't listen to CNBC, CNN, etc. The media are masters of feeding the herd mentality that successful investors avoid.

* Don't log on to their accounts every day or check quotes multiple times per day. They take the long view. They don't talk about their stock picks, winners/losers with friends. They don't follow hot tips. They keep their own counsel.

* Don't put their egos into their trading. Pride in a good trade is as harmful as shame or anger or grief over a bad trade. Some trades will go well. Some trades won't go well. It has nothing to do with the investor's intellect or self worth.

* Find a good plan and stick with it. A great batter in baseball only succeeds four out of ten times at the plate. Investing is a marathon, not a sprint.

Most retail investors lose money in the markets because they let fear and greed, their emotions, interfere with their trading success. In study after study, it has been proven that while average growth funds earn between 11-12% per year, the average investor's returns range from -2.2% to +3% per year, depending on which study you quote.

Why the poor results? Because average investors can't control their emotions and let fear and greed and ego dominate their trading decisions.

While there can never be any guarantee of success, most investors find that understanding fear, greed and the herd mentality and then learning to manage their emotions can lead to better outcomes for their investing activity.

All material herein is believed to be correct but its accuracy is not guaranteed. This article represents solely the opinions of John Nyaradi and readers are encouraged to consult their investment advisors prior to making any investment decisions. All information herein is for general informational purposes only. The information is of an impersonal nature and should not be construed as individualized advice or investment recommendations.
John Nyaradi
Wall Street Sector Selector