Investing with a Trading Plan
Planning and Emotional Preparation Can Equal Investment Success
Feb 8, 2009
Many investors have likely at one point or another experienced the tremendous stress that can be involved with watching their investment portfolios decrease in value. Over the years these investors have likely heard the Wall Street ‘buy and hold for the long term’ mantra repeated over and over. That might be acceptable advice for someone with a very long term outlook and little time or desire to watch his investments on a consistent basis. But, what about those investors who find the risk involved with watching their investments decline in value by 50 percent or more absolutely unacceptable? These people likely understand that there are no guarantees that these investments will ever make it back to the levels from which they fell. And, even if they do make it back how long will it take? The answer for these investors might be to develop a trading plan, along with the mindset to follow it through, that can help them navigate difficult financial times.
The Trading Plan
A key tool in the arsenal of a successful investor is a trading plan that begins with identifying the conditions under which he will both enter as well as exit the market. That’s right. The very first step not only entails identifying when to enter the market but when to exit it as well, whether for profit or for loss. Anyone who has ever sold in panic based on a negative news event or bought in excitement based on a positive news event can understand just how important this can be as oftentimes investors will discover that they either sold very near the bottom or bought very near the top due to these types of emotional decisions.
Trading plans can vary based on the individual. All basically begin with two primary considerations:
- What type of investor/trader does one consider herself? (ie: long term, short term swing trader, day trader, etc)?
- What is one’s risk tolerance? How much can one afford to lose?
While trading strategies may vary by individual all good trading plans should be based on proven market principles. According to Bill O’Neil, founder of Investor’s Business Daily, in his book, The Successful Investor, “Most people both investors and advisors got hurt during the 2000 to 2002 downturn because they never took the time to learn sound investment rules and principles”. Still, some might resist and consider trading plans a tool for traders, who tend to move in and out of the market very quickly, as opposed to investors who might be in for the long term. I.e.: a day trader who purchased a stock for $12 may need to exit the position at $11 taking a $1 loss but a long term investor can afford to wait out the correction based on the idea that the stock will move higher over the long term. While this might often be true even a long term investor can benefit by having a predetermined exit strategy based on risk tolerance combined with sound market principles, rather than sink with the ship for no reason other than he had labeled himself a long term investor. The financial crisis that began in 2007 is a recent example of where a trading plan may have alerted long term investors that they should have exited positions.
This article has addressed two of the primary considerations of developing a trading plan. For a more in depth look at trading plan considerations one can read, Ten Steps to Building a Winning Trading Plan. The Investor’s Business Daily newspaper is a solid resource for information on topics such as market trends that one might want to incorporate into her trading plan.
Psychology and Investing
No discussion of successful investing/trading would be complete without the mention of psychology. Even with a finally tuned trading plan in place one can still feel under increased stress knowing that his exit limit has just been hit and he has been ‘stopped out’ of his trade for a loss. The emotions associated with this loss can be overpowering and lead one to want to abandon his trading plan and stick with the losing trade for purely irrational reasons. This impulse must be overcome. According to Peter Lynch in his book, One Up on Wall Street, "Ultimately it is not the stock market nor even the companies themselves that determine an investor's fate. It is the investor….It is personal preparation, as much as knowledge and research, that distinguishes the successful stock picker from the chronic loser."
At the heart of personal preparation is developing oneself emotionally for the ups and downs of the financial markets. One way to condition oneself for the rigors of investing is the practice of yoga which can help one overcome the overwhelming impulses of emotions. According to Darshan Singh Khalsa, in his book , Yoga Secrets for Business Success, yoga can help one to “Learn to be a leader, relax in three minutes, energize immediately, relieve headaches, conquer fear and depression, manage anger, improve decision-making, sharpen concentration, become more intuitive..” These are exactly the traits of many successful investors.
Investing with a Plan and a Controlled Emotional Mindset
With a dedication to the development of a sound trading plan combined with a consistent practice of not allowing one's emotions to control investment behavior, many likely have it within themselves to become successful investors. It’s no doubt a difficult journey, but once complete it will likely have been well worth the effort.
