Prepared by Tara, senior analyst at BAD BEAT Investing
Hi. it was a horrific day in the market today (Friday 2/21). And it can lead to some horrific decision making. Before devling into our topic, I wat to first tell you that, as a follower, we wanted you to be aware of a flash sale to Join our investing service, BAD BEAT investing, for $280 off the price, this weekend only. Through this link, you can join, and save (new members only!). Its open for 3 members.
$280 off? Hell yeah why not? Click to start winning today
no thanks, I do not like winning
Ok, if you change your mind, note this is the best sale we have offered since Black Friday. It will remain up, with a money back guarantee. So back to this ugly day. It was rough. Driven by some negative economic data, and concerns from (UNH) being probed. Algo selling was triggered, and stop losses were being taken out for many. But at BAD BEAT, we all remained calm. How can this be as Seeking Alpha’s premier trading service?
This was a note we sent out to our members, and we are sharing it with you. A few years ago, and our long-time members may remember this famous quip at the service perhaps, but I said that to be a successful trader and investor, you need to have a total disregard for money. And what the means, is that you can’t obsess over the day to day movements. There is not faster ticket to alcoholism and therapy then to watch your stocks tick by tick. Sure, active monitoring of a portfolio is important for navigating the changing tides of financial markets. But it is also essential for you as individual investors to manage your behavioral impulses of emotional buying and selling that can come from following the market’s ups and downs. You have to remove emotion from the equation. Indeed, many investors seem to pile into investments at market tops and selling at the bottoms out of fear, uncertainty, and doubt. It is not uncommon to get entangled in media hype or fear, but time and again we see folks chase investments at peaks and dump during the valleys of a stock/market cycle.
Embrace some rules
How can you navigate volatile markets while also keeping a level head, and keeping a portfolio diversified for the best overall returns through all types of market environments? The key is to avoid both euphoric and depressive set of minds that lead to poor decision-making. It is easier said then done but investing based on emotion is the main reason why so many people are buying at market tops and selling at market bottoms. Embracing stops (even if the stock would have rebounded) often saves you tremendous money long-term. Further, taking reasonable gains in the short-term while embracing our house position approach has proven to be a wonderful wealth building strategy. Staying the course through short-term volatility is often the key to longer-term success as an investor, but also recognizing when there are technical and/or fundamental break downs is key.
Emotions are powerful
Now, you may not be aware, but the academic literature has looked at this quite a bit. In fact, trader behavior has been the focus of many studies, and many academic theories attempt to explain the regret or overreaction that buyers and sellers often experience when it comes to money. Keep in mind my quip, that to be successful, you almost need a total disregard for the money. It is the long term goal and we have successfully made many long-term members either wealthy, educated, or both. The reality is that your psyche can overpower rational thinking during times of stress, whether that stress is a result of euphoria or panic. Euphoria can make you feel like it will never end. But the depressive side can make you think there is something wrong with you or the approach. Look, even at this successful service, you are going to lose money on SOME trades. It is going to happen. The key is to win in the long run. And taking a rational and realistic approach to trading during what seems like a short time frame for capitalizing on euphoria or fearful market developments is important. Now, I will tell you, many non-professional traders/investors typically put hard-earned cash in investments for the sake of receiving a return. But when you see trades or investments lose value due to market developments at times, it can lead to negative emotion. The short-term losses can cause stress and second-guessing. The truth is MOST people find, especially early in their investing careers, that they have a low risk tolerance because losing money is painful. I want to share one thing with you. Your self-worth is not reliant on the short-term performance of trades or moves in your port. You can offset this by coming in with some rules. Such as having target exits and stops. You also want to understand risks involved with single stocks, not matter how good they may be. This can help take emotion associated with investing out of the equation.
Mitigation approaches
While feeling good about making back-to-back-to-back winning trades, especially when they are short-term, is natural, one must be careful not to believe this is how it should always feel. When the bull rages and investor sentiment becomes one of general exuberance, it can lead to a feeling of “you can’t go wrong.” But as we know, it can go wrong. While rare, we have experienced taking 2 or even 3 stops in a short time. Likewise, you cannot let yourself feel like “I am no good.” Instead, realize this is a life long learning process. Even I am not immune to getting ticked off when we miss a target exit by a few cents, then see the stock retreat. It can really be frustrating. But we should see the positive. That is, our research pinpointed an exit that was ‘nearly’ spot on. At the same time, when the market is really getting hit and setting up a good entry, past pain can lead you to think “I want to sit this one out.” While you can’t lose what you don’t “put in the middle,” you can’t make anything. The fact is that stock selloffs and even bear markets are always lurking around the corner and come with many of their own caveats. One mitigation strategy is diversification. Even in our trades, we often have a number of different sectors represented. Another mitigation strategy is to learn how to sell covered calls, to generate income, and to say “I am ok taking profit here if called away”. Further, learn to sell puts as a way to buy stocks if they fall to a level you are ok owning the stock. If it does not get there, you keep the premium.
Rational thinking and having a team in your corner
Keep in mind, we are here to take a lot of the guess work out. I don’t think anyone who has come through our service can argue we do not stack the odds in your favor. But black swan events, macro changes, a bad earnings, it all happens. Moreover, while we have not had a bear markets since 2020 (recall in Feb 2020 we made the call to sell everything, get out of the market, and consider going short), when the next one comes it may not be as clearly written on the wall. And bear markets can be difficult to navigate when you see equity holdings lose value while safe havens become more enticing due to their rising returns. During these times, it can be hard to choose between buying equities at market lows or buying into cash and interest-bearing products. We would say one “insurance” approach is to own market puts if you fear this is coming. At any given time we are holding a few longer dated (SPY) or (QQQ) puts as a minor, very minor, hedge. We often notice too that traders get the most emotional investing if there is bad market timing. We too have been guilty of this at times, despite all the research and modelling being done. But keep the long-term in mind. Using rational and realistic thinking to understand when an investment may be in a development cycle is the key to evaluating interesting opportunities and resisting bad trading ideas. A prime example? When we see members reacting to every single piece of latest breaking news even tangentially related to their holding[s]. Often we see this as a sign that decisions are being driven by emotion rather than rational thinking.
Buying a top and selling a bottom
Have you ever bought a top or sold a bottom? Guess what, we have too. And, while it is quite rare for us to this day, it can and likely will happen again. And you are not alone. The idea that many traders buy at the top and sell at the bottom has been academically proven by historical money flow analysis. I won’t go into heavy detail there, but money flow analysis basically looks at the net flow of funds for mutual funds and other participants and often shows that, when markets are hitting peaks or valleys, buying or selling is at its highest. And retail traders (non professionals) are often right there doing the same. Indeed, there is a group think mentality often. There is a lot of psychology that drives the markets, and often, it is a herd mentality. But if you can limit emotions and stick to the data, often you will outperform near-term, and almost certainly long-term. A good historical example. During the financial crisis of 2007–2008, so many investors withdrew money from the market and money flows to mutual funds turned negative. The net fund outflows peaked at the market bottom and, as is typical for market bottoms, the selling created overly discounted investments, which eventually formed the basis for a turning point and the market’s next ascent upward in early 2009. But if you had started buying before that moment, you still did very, very well.
Longer-term mitigation
So how can you remove the emotion? We are human. It is hard. Two of the most popular approaches to are dollar-cost averaging and diversification. The way we scale into trades hits the first point, and the second way has been addressed. The third way is to have a plan. That is, a plan to enter a stock and exit it (whether for gains or losses). This takes some of the guesswork out of decisions and reduces the risk of poor timing due to emotional investing. We especially like the dollar cost approach for long-term investments. While our house positions make up the bulk of our long-term investments, if you have a 401k or 403 or 457, regular buying and holding diversified funds leads to time in the market and leads to success. How does that work in trading? We cannot speak for other services, but over the long-term 4 out of 5 of every trades historically hits its target exit before its stop. The math works. So, even if you get nailed for 2-3 stops in the short run, you preserve cash and move to the next one. In poker, we call it protecting your stack so you can win a big pot in the next hand, or the hand after that. Simply substitute ‘trade’ for ‘poker hand.’ Further, while our trades are diversified, long-term a diversified portfolio can take many forms such as investing in different industries, different geographies, different types of investments, and even hedging with alternative investments like real estate and private equity. When one underperforms another often outperforms.
A lifelong journey
The bottom line? Whether you are a multi-decade investors or brand new. Learning to remove emotion is a lifelong journey. It is hard. As humans we are emotional and reactionary, and fear and greed are heavy hitters in that arena. When it comes to humans and money, fear and greed can be powerful motives. To mitigate, embrace stops and embrace profit taking. Having a plan. Scaling in and diversifying. Trading and investing without emotion is easier said than done. Understanding your own risk tolerance and the risks of your investments are a good place to start. Active understanding of the markets and your sectors and your company’s operations in stocks you own are key. And remember, we do our best to take the guesswork out of much of the equation. However, as soon as you look at your investing and trading with a rubric and rules, the better you will do both financially and from a mental well-being standpoint.
Stick with our trades, and you will continue to make money over time and crush the market. We will also protect you when the market goes down. Continue winning with BAD BEAT Investing!