Essential Stock Market Lessons – Part 2: Learn from your Mistakes (and Don’t Repeat Them!)
Looking back on my past three years of investing is a little bit “cringe” at times. You see, my investing history is literally strewn with what seem to be (with the benefit of hindsight) completely obvious mistakes. These mistakes cost me countless dollars and caused me significant psychological pain as I watched my hard earned savings vanish before my eyes.
But when I look back, the thing that irks me the most isn’t the fact that I made these mistakes – we all know when you’re new to something, mistakes are inevitable. It’s the fact that I made those very same mistakes over and over again.
That’s one of the few things I’d change if I had a chance to do over, because I pride myself as someone who gives things a crack, experiences failure and learns from my mistakes. It’s also one of the three key lessons I’d advise anyone who’s investing and/or trading in the markets to take note of – Make sure you learn from your mistakes, and do your very best not to repeat them time and again!
There’s a quote I’ve read in the past (from a guy who was apparently pretty smart) that I think sums up how I feel about repeat “offending”:
Insanity is doing the same thing, over and over again, but expecting different results.
That rings very true to my ears and I’m sure you can all think back to times in your life where you’ve portrayed a little bit of “stupidity”. Whether it’s that last attempt at losing weight where you simply tried the same old diet and exercise routine, or your attempt to save a little more cash each month without actually making a budget – things usually end up the same, because you haven’t changed anything!
The same goes with trading and investing – if you’re losing money, or not making as much as you know you should be, you need to change your approach – and that takes effort.
Before I get into the best ways I’ve found to avoid repeating investing mistakes, I figure it’s probably prudent to start off by examining some of the most common mistakes investors and traders make.
I put the question, “what are some of the biggest investing mistakes that you’ve made and struggle to correct” to a bunch of people in the investing forums I frequent. The following is a selection of some of the most common answers both from my own experience and the experience of others on the forums:
1. Chasing “hot stocks” and buying near the peak.
How many times have we all done this – buying into a stock for no other reason than they are going up (usually rapidly). A company makes a breakthrough announcement and a stock jumps 20%, 50% or even 100%+. You’ve missed the start of the run but end up “FOMO” buying, hoping to make some quick gains on the back of the stocks freight train like momentum.
The price then tanks just as fast as it rose and hindsight shows you’ve brought near the peak. Unless you were diligent with your stop losses, you’re now well underwater and you end up selling for a loss. I can definitely relate as, unfortunately, I did this many a time when I first started out (and occasionally still today, if I’m honest).
2. Confidence bias – thinking you’re a better investor/trader than you really are.
This happens to us all, something I like to term “confidence bias”. During a strong bull market like we’ve experienced over the past 5 or 6 years, the “rising tide that lifts all boats” makes everyone think they are an investing genius (unless you bought into resource stocks…my bad). You’re success leads you to believe you’re a “market whisperer” and you end up throwing all your spare cash into equities thinking you’re going to “rain gold coins” down upon your portfolio.
However tides always turn and your over confidence has meant you haven’t even noticed the tide flowing out around you. Before you know it you’re heavily under water and you begin to realize that you’re not the hot shot you thought you were. This generally has a very negative effect on your portfolio/bank balance.
3. Irrational Confidence and/or skepticism.
Most would associate with the “confidence” part of the above statement whereby you hold a stock long past it’s used by date in the hope of irrational gains that don’t match up with the companies fundamentals. This is often associated with a variation of point 2 above – “confirmation bias“. Everyone wants to think the stocks they own are going to the moon, I mean who intentionally buys dud stocks (no one…I hope)?
But having an irrational expectation of where a stocks price is going to move is a real portfolio killer. This is particularly true when it comes to stocks at the speculative end of the market where totally irrational amateur blue sky valuations are a dime a dozen. How many times have you heard statements like “this one’s a real game changer” or phrases like “highly disruptive”. Statistics show that the vast majority of speculative stocks go nowhere, and a healthy dose of skepticism should be part of any valuation of a speculative stock (trust me, I’ve learned the hard way through experience).
On the flip side, I thought I’d better take a quick moment to point out something that not a lot of people mention – that irrational skepticism/bearishness can also make you pay in the form of opportunity cost. I’ve mentioned in other posts that I’ve been guilty of being overly skeptical about certain market sectors in the past and missed out on significant gains. There’s definitely room for a healthy dose of skepticism when it comes to investing, just make sure you’re not over doing it and missing out of quality opportunities. Also remember that it’s often at the height of despair that the best value can be found.
4. Assuming the past is a guide to future performance
Generally speaking, assuming a stock has performed well in the past does not necessarily mean it’s going to perform well in the future. The market is a highly cyclical beast and a particular stock or sector is very unlikely to outperform for exceptionally long periods.
The same can be said for things like selecting fund managers or superannuation schemes. Many studies have shown that very, very few individuals are able to stay ahead of the pack, year in year out. In fact these studies have shown that in most all cases, the opposite is in fact true in that yesterdays laggards are often tomorrows big winners. Contrarian thinking should definitely play a part in your investing thinking.
That doesn’t mean past performance shouldn’t be considered at all – in fact it should be one of the key things you do look at, but make sure you take a step back and look at the “bigger picture” stuff – overall market cycles, sector cycles, changing trends and the like, before assuming things are going to continue “as is” ad infinitum.
Chances are, if a particular stock or market sector has been running hot for years on end, valuations are getting lofty and you can probably find better value elsewhere.
5. Not reviewing your brokerage costs.
This is more of a killer if your actively trading or managing your investments and are frequent buying and selling. It may not seem like a big deal, but brokerage adds up more than you realize. For example, a quick analysis of my brokerage costs over the past year showed me that I’ve spent over $2,000 on brokerage – no chump change.
As a reasonably active trader/investor I know I could sign up with a different broker and pay at least half, if not a quarter what I’m currently paying. That’s $1,000 to $1,500 more I could have had in my pocket from just one years trading. I’m looking at an upcoming ski trip to Chile – there’s my flight paid for in brokerage savings alone.
Writing this post has made me realize my brokerage cost is an area I definitely need to look into.
6. Not documenting and analyzing your investing/trading decisions and performance.
This is really the key point which underpins all the other mistakes mentioned above. It’s the one thing that I didn’t do for a long time, and something that has dramatically increased my returns when I finally got around to tracking my investments and trading activity.
Documenting your decisions is vitally important because, more often than not, you wont even realize what it is you’re doing wrong. In order to figure that out, to really dig deep into your investing and/or trading activity, you need to have a detailed picture of exactly what it is you’re doing. Most people don’t take the time to do this because it takes time and effort. Us humans generally hate things that take time and effort, but believe me, it’s well worth the effort.
If your not documenting your investing/trading, you’re simply flying blind. You’ll probably eventually see improvement, but not before experiencing countless losses and financial (and most likely psychological) heartache. Your progress will be painfully slow – unnecessarily slow.
Not only that, but market conditions are constantly changing – charting patterns, fundamental triggers, even whole sectors that provided good gains a year ago can become obsolete or stop being as fruitful. Keeping tabs on what is working and what isn’t is vitally important if you want to maximize your investment gains and stay ahead (or at least keep up with) the pack.
Before I move on to some simple ideas you can use to implement a documentation and review strategy, it’s important to stress that there are two parts to point 6 above – “documenting” and “analyzing” (reviewing). It’s all well and good collecting data on your investing activity, but you HAVE to make the effort to actually dig deep and analyze what worked and what didn’t – raw data is useless if you don’t to anything with it.
So lets look at some simple, effective ways in which you can implement an investment documentation and review strategy which you can use to help you figure out what you’re doing right and what you’re doing completely wrong so that you can achieve far better returns from your investments.
Investing documentation and analysis tips:
The following is a list of steps you could (and really should) take to start better understanding your investing activity. Implementing the following strategies will enable you to figure out what’s working so that you can “rinse and repeat”, at the same time allowing you to cut out the behavior that’s causing you to lose money.
Trust me, it’s going to have a big impact on your bottom line.
1. Document Everything!
This is really the first and most simple step. You need to keep a diary of all of your investing and/or trading activity. By this, I don’t simply mean just your entry price, reason for buying and target price. I mean literally EVERYTHING. This includes things like:
- Entry price
- Position size
- Fundamental reasons for buying (Financial metrics i.e. low P/E, cash backing, new acquisition, consistent profit growth etc)
- Technical reasons for buying (i.e. chart pattern, support/resistance, candlestick pattern etc.)
- Target price and/or condition that will trigger you to sell
- Brokerage cost
- Stop loss
- General thoughts around why you’ve bought and how long you plan to hold, i.e. “tip from a friend”, “general gut feeling”, “hold till dividend” etc.
- Dividend payouts
- Profit/loss upon closing position
- General thoughts following closing out your position, i.e. “held too long”, “didn’t stick to exit plan”, “sold because of shift in market sentiment” etc.
You need to come up with a documentation system that works for you. I know many people that have a physical diary that they write in. Others I know have an excel or word document. I personally use a free online “cloud” based service called TradeBench* and I’d recommend anyone looking to start up an investing diary at least check it out. It’s probably more suited to the active trader and/or investor but could just as easily be used by the long term investor.
*Note I’m not affiliated with TradeBench in any way shape or form, I just personally use and love the service.
2. Review and Analyse your Performance
This is actually the most important part of the whole process. Once you’ve collected your raw data, you’ve gotta go through it with a fine tooth comb and figure out what has worked (i.e. made you money) and what has been unnecessarily draining your portfolio. This means looking at EVERYTHING you’ve recorded, not just your reasons for entering a stock.
For example, perhaps you’ve notice that most of the stocks you’ve purchased based on a particular technical pattern, say a breakout from a consolidation, have performed badly. This doesn’t necessarily mean your reason for taking a position was a bad one. The problem may lie with your exit strategy and you’ve simply been holding for longer than you should have (something that’s often the case with short term investments or trades).
Perhaps your investments based on your analysis of the financial metrics of a company have performed badly, indicating you may need to go and do some homework on how to analyse a companies balance sheet better. You should avoid making investments based on this method of identification in the mean time.
Maybe you simply notice that all the investments you’ve been making based on your buddies “hot tips” have been a flop. It’s then a no brainer – stop listening to your buddy!
On the flip side, it’s important to look at what is working and making you positive returns. It’s these things that you’re going to repeat, over and over again until the day something changes and they are no longer producing winning investments.
I thought it would be worthwhile including a quick screen shot of one of my reports from TradeBench that I use to analyse my performance so you can see the kind of things I look when analysing my trades and investments. You’ll see below I loaded up all my trades I’ve made in the last three months where I took a position in a stock based on identifying stocks based on a “breakout” technical pattern I’ve developed. I made a total of 8 trades of which 6 were a flop and only 2 provided winners with an overall average loss of -14.24% per trade. This suggests that my trading based on identifying breakouts is not working for me at present.
Now, as I mentioned above, I can’t assume that my entry criteria is the sole reason for my trades failing. In fact, by digging a little deeper I found that of my 6 losing trades, 5 actually increased (by at least 10%!) from my buy in price, before falling down below my entry level. This suggests to me that my problem actually relates to my exit strategy, rather than being able to accurately pick a breakout.
I can then move to make changes to this strategy – in this case I need to be a lot more conservative when it comes to my exit targets and/or conditions.
3. Make Changes to your Investing/Trading Behavior Based on your Analysis
This is really the bread and butter, and should be the easier part of the whole process. Once you’ve taken the time to document your trading/investing activity and analyse what has and hasn’t worked for you, it’s time to make actual changes. Remember, “Insanity is doing the same thing, over and over again, but expecting different results” – this part is all about making those changes so we can achieve a different result (i.e. a positive impact on your returns).
It’s a simple but powerful concept – cut out what isn’t working and continue doing what is. If you’ve been buying based on the assumption of an upward breakout, but the majority of your trades have gone in the opposite direction, stop trying to buy the breakout, or at the very least, change the way you identify potential breakout trades and then re-assess.
Conversely, if your long term investments that you made based on identifying solid company fundamentals are consistently growing your portfolio balance, by all means, keep doing what you’re doing!
Lastly, be aware that as I mentioned earlier in the post, things that worked well in the past wont necessarily work forever. It’s vitally important that you keep an eye out for changing conditions. This applies across both short and long term time frames. This means that the “record and review” process has to be a fairly regular occurrence. I’m a bit of an “investing nerd” in that I get enjoyment from researching and analyzing anything investment related – I have no trouble sitting down for an hour or so and running a fine tooth comb over my investing data. But, generally speaking, a longer term investor should aim to review things at least once a month or so and the general rule of thumb is more actively you manage your investments, the more frequently you should review what your doing.
I hope this post has helped give you a few ideas about how you could go about tracking and analyzing your investment decisions (if you’re not already). I know tracking and analyzing my investing behavior has been one of, if not the most important factors which helped me transition from losing money hand over foot, to making sound and financially beneficial investing decisions more often than not.
The Nude Investor