Wednesday, April 1, 2015

Importance of staying in the market vs. timing the market

Often times, after we purchase a security with a sole intention of cashing out with hefty gain at a later time. The stock price immediately starts its slide in the opposite direction of our position. Personally, I have had this experience many times. And what is interesting, is that the same pattern gets repeated often enough that I decided to analyze the situation and once for all decide what kind of steps I should take in order to have fewer losses.

Here are my thougts in regards to this crucial issue of timing the trades. Every investor has his own time horizon for holding the trade. Some people dedicate mere seconds, minutes while some dedicate days, weeks or months. There are rare group of people, who dedicate years until they make a decision to part ways witht the company. The latter approach is suitable for people with large asset base, but not much to retail investors (like me). This is very important distinction to make, as it has a direct impact on the emotional state of an investor to the underlying movements of the stock prices.

For a market participant, who trades intraday, and can only dedicate 3-4 hours for the transaction, every tick of the price has a direct impact to his bottom line, than to a person who holds his positions for weeks. The former participant, hopes to achieve small gains, by executing more transactions. While the latter participant is hoping to make bigger gains by waiting out bigger price moves in the underlyign security. To achieve this results, he is foregoing many more opportunities.

The two approches described above are different in some aspects, but has one goal in common, which is making money. The former approach has limits in the time dedicated to the fullfillment of the transaction. As the saying goes, market can stay irrational longer that an investor stay solvent. That's why it is important cut losses as much as possible.

In my experience, there were a number of mistakes, that repeated many times.

They are, in no particular order: (1) no cutting losses, or not having a strict stop loss philosophy for each trade, (2) having a huge positions (with margin), that has a negative effect if the position moves in the opposite direction, (3) buying and selling too much (overtrading)

These are some of the mistakes, and they directly come from not having a clear path for each trade and mixing speculation with investing.

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