Thousands of individual investors have pulled their money out of full-service brokerage accounts and are now trading and managing their stock market investments online. They'd do well to bear in mind the two great secrets of success in stock market investing: cutting losses early and riding with your winners for as long as possible-up to the point where they turn risky.
Secret One: Cutting losses early
In a classic essay on investing, "The Loser's Game," author Charles D. Ellis compared investing to playing tennis. Tennis pros, Ellis observed, possess qualities that most amateurs don't-like superior speed, strength, athleticism and shot-making skill. The average amateur does not win a match the way that pros do-by making breathtaking shots. Instead, they tend to win by simply not losing. They keep the ball in play long enough to let their opponent make the first mistake. In other words, amateur tennis games aren't really won by anybody so much as they are lost by the weaker player. Average players tend to be their own worst enemies, defeating themselves by attempting difficult shots when they'd be better off playing for the safe, sure thing.
Investing in stocks has a great many similarities. Too many investors become their own worst enemies by ignoring what should be obvious. They fall in love with a stock they own and then fail to recognize when it's time to sell. They fall in love with a stock because it's an iconic name like Apple or Berkshire Hathaway, or they become infatuated because of all the time, effort and ego they invested in picking the stock in the first place.
Secret Two: Riding Winners Longer
The other trick to maximizing profits is to stick with a well-performing stock for as long as possible-up to the point where owning it becomes risky. True, you won't lose money taking profits prematurely, but neither will you make much money. Legendary trader William Eckhardt puts it this way: "Amateurs go broke by taking large losses; professionals go broke by taking small profits."
Even the pros have a tendency to sell their winners too early. As Eckhardt explains, that's because it's actually against human nature to operate in a way that maximizes gains. This is a vitally important point. Instinct tells us to act in ways that maximize our chances for gain, but that's different from maximizing the gains in total. We instinctively want to maximize our number of winning trades (and to minimize our number of losing trades). What we really ought to focus on, however, is something else-the overall extent of gains and losses, which are what really matter.
How do you avoid falling in love with a stock and holding onto it long after you should have sold it? And how do you know when a winning stock you own is running out of steam? It's less difficult than you might think. Future articles in this series will elaborate upon the ABCs of developing and pursuing an objective investment methodology, using the expanding array of online stock market tools and data that now available to everyone at little or no cost.
Secret One: Cutting losses early
In a classic essay on investing, "The Loser's Game," author Charles D. Ellis compared investing to playing tennis. Tennis pros, Ellis observed, possess qualities that most amateurs don't-like superior speed, strength, athleticism and shot-making skill. The average amateur does not win a match the way that pros do-by making breathtaking shots. Instead, they tend to win by simply not losing. They keep the ball in play long enough to let their opponent make the first mistake. In other words, amateur tennis games aren't really won by anybody so much as they are lost by the weaker player. Average players tend to be their own worst enemies, defeating themselves by attempting difficult shots when they'd be better off playing for the safe, sure thing.
Investing in stocks has a great many similarities. Too many investors become their own worst enemies by ignoring what should be obvious. They fall in love with a stock they own and then fail to recognize when it's time to sell. They fall in love with a stock because it's an iconic name like Apple or Berkshire Hathaway, or they become infatuated because of all the time, effort and ego they invested in picking the stock in the first place.
Secret Two: Riding Winners Longer
The other trick to maximizing profits is to stick with a well-performing stock for as long as possible-up to the point where owning it becomes risky. True, you won't lose money taking profits prematurely, but neither will you make much money. Legendary trader William Eckhardt puts it this way: "Amateurs go broke by taking large losses; professionals go broke by taking small profits."
Even the pros have a tendency to sell their winners too early. As Eckhardt explains, that's because it's actually against human nature to operate in a way that maximizes gains. This is a vitally important point. Instinct tells us to act in ways that maximize our chances for gain, but that's different from maximizing the gains in total. We instinctively want to maximize our number of winning trades (and to minimize our number of losing trades). What we really ought to focus on, however, is something else-the overall extent of gains and losses, which are what really matter.
How do you avoid falling in love with a stock and holding onto it long after you should have sold it? And how do you know when a winning stock you own is running out of steam? It's less difficult than you might think. Future articles in this series will elaborate upon the ABCs of developing and pursuing an objective investment methodology, using the expanding array of online stock market tools and data that now available to everyone at little or no cost.
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