Investing — An Endless Game
TLDR
I assume that if you’re a seasoned trader or investor, that you won’t be reading this. On the very unlikely chance that you do indeed have some experience in this area, I would be willing to bet that you will still get something out of this blog. Though if I were to write a blog for more experienced investors/traders, I would call it “The Art of Investing” and it would be focused solely on the ability to stay in the game whilst maintaining a healthy lifestyle. Much harder to do than most may think.
This blog is aimed at beginners though, or people wanting to get a better understanding of this field before they take the plunge. I focus on investing rather than trading since I’m a better investor than trader.
This blog is so long that even a proper TLDR would be quite lengthy so I will leave at this: I have condensed my knowledge and experience into this one blog, that’s how I roll, so it’s a long read, but in my completely biased opinion, well worth the time.
Introduction
Why should you read this and give any attention to what I’m writing about this topic? Well, I have been investing and trading for 5 years with some degree of success and many failures that educated me on this activity. My practical experience is in one of the most challenging markets there is, arguably the most challenging. I think most traders and investors will agree with this assertion. My experience is trading and investing in the crypto market.
In order to have any chances of success I had to read and learn about trading and investing in the traditional markets. First because there wasn’t much literature focused on the crypto markets and what there was available, was in my opinion, crap. So I read much about investment and trading from some of the best traders and investors in the world and some learning resources like babypips and others.
But you see, there’s nothing like doing it to learn it and improve. And especially when it comes to trading and investing. You can practise paper trading or demo trading for as long as you want, but once you put your real money at risk, everything changes and it’s like you’re starting anew. I’m not saying not to paper trade for a month or two to improve your knowledge and skills, on the contrary, you should definitely do that before you risk your own money, just be mindful that when you start trading with real money, everything changes. Everything changes in you, and you only, because when you paper trade, you are trading in the real market, you just don’t lose or win real money.
My aim with this blog is to take you on a journey through the captivating universe of investing. A universe that intriguingly mirrors an endless game — a game filled with limitless opportunities and constantly evolving strategies, and a game that has no end. Anyone can leave whenever they choose to, but the game will continue being played well after we, individually, are gone, dead.
Why Invest?
The markets are going nowhere and amidst the current economic turbulence, the importance of understanding investing as a means to maintain financial stability is more crucial than ever. We have adopted an economic philosophy that makes it an absolute requirement to be invested in assets, and make sure we don’t store our wealth in cash. It can be hard or soft assets, that’s a decision for you to make and we’ll look into this later in this blog. But for now just to distinguish between the two.
Hard assets are tangible, physical resources with an implied fundamental value. You can think of natural resources like oil, timber, uranium, etc… precious metals like gold or silver, real estate, art, collectibles and so on.
Soft assets are intangible assets, so they do not exist in the physical form. Some examples are stocks, bonds and other securities as well as intellectual property or even brand recognition. These assets do not have an implied fundamental value.
I just want to quickly go back to my comment around the fact that we can no longer store our wealth in cash. I want to acknowledge that holding cash can be an effective investment strategy, during certain periods. These periods are invariably short-lived though and carry a lot of risks, as they resemble trading more than investing.
During challenging periods such as what we’re living through now, the true value of investing really shines through.
I am a fervent believer and supporter of the idea that you must invest in yourself first, before you invest in anything else. You invest in yourself in a few different ways. Self-development; by studying and learning new skills and acquiring knowledge that you can effectively apply in the endeavours you’re set out to pursue. Health; by exercising regularly, mindful and healthy eating and by meditating. And relationships, by cultivating positive relationships and cutting off negative ones.
But this blog is about financial investing, and from this point forward, when you read the words investment or investing, it’s meant as financial investment unless specifically stated otherwise. And it assumes that you already make the non-financial investments aforementioned. As you will read later in this blog, these non-financial areas are crucial for carrying out your investment strategy effectively.
Understanding Investing
Let’s start by demystifying investing. At its core, investing is the act of allocating resources, typically money, with the expectation of generating an income or profit. It’s about making your money work for you. You should understand as well that the market is not out there to get you, to take your money away from you. The market doesn’t care about you, doesn’t know you exist.
The “market” is the immense group of “people” that is willingly playing the investing and trading game. It’s composed of many players that play different roles, mainly the roles of buyers and sellers, but many of those players are not even people, they’re software algorithms that play by the same rules as all other participants.
You may think you’re at a disadvantage competing with algorithms and that there’s no way to win at this game, but you would be wrong. Most players are humans, and all owners of the capital at risk are humans. We don’t yet have computer programs that own the capital they’re trading/investing. This will become relevant later on. The market is in essence, people. Many people, from all backgrounds around the world.
Remember this, the market will not take your money or give you money. You either give your money to the market, or you take your money from the market.
First lesson
Investing is not synonymous with trading. Trading is a short-term game, all about buying low and selling high in a relatively short period. Investing, on the other hand, is a marathon, not a sprint. It’s about building wealth gradually over time, not chasing quick wins.
For the rest of this blog I will assume that you are either interested in starting to invest or are already invested in some asset class or classes. Now, before we jump into the investing lessons, there’s a test you need to take. This test consists of a number of critical questions you need to ask yourself.
Know yourself
You see, before you start investing, you need to know what you want and you need to understand who you are in this world. You need to be able to answer the following questions. All of them.
What do you want? And I don’t mean this in a broad, philosophical sense. I’m talking about concrete financial goals. Are you looking to grow your wealth? Save for retirement? Have a steady monthly income?
But more important than what you want is, what do you want it for? Purchase a home? Fund your children’s education? Leave your descendents a good heritance? Change your lifestyle?
Your goals will dictate your investment strategy, so it’s crucial to have a clear target in sight. There’s no point in starting your investment journey if you do not have a clear, specific, goal in mind. This will become clearer the further you read.
Those two first questions should inform the answer to this next question. What’s your time horizon? Do you expect to see a return in 3 months, 6 months, 1 year, 5, 10, 20? Your time horizon will be key in defining an effective investment strategy.
What’s your risk tolerance? Are you willing to make very risky bets or are you more conservative? Your age should weigh heavily on this decision. The younger you are the easier it’s to take riskier bets and the opposite is true. The main rule to understand here is that even though the rewards are always higher on riskier bets, the probabilities of losing the bet are also higher. This means, for very risky bets, you will lose most of the time.
How much money are you willing to put on the line? You need to understand that even the most conservative investments carry risk. Just look at the number of banks going bankrupt due to their investments mainly in government bonds. When investing do not think about the reward, or at least, do not make decisions based on the reward, always base your decisions on your loss. How much money are you willing to lose if you’re wrong on an investment?
How much market volatility can you handle? Can you handle crypto or even penny stocks volatility? Or will you only be able to sleep at night if your money is invested in government bonds? Your time horizon and investing style should align to your ability to handle volatility. You’ll read here that one of the most important areas you want to monitor and make sure you’re effective with, is your sleep. It’s a major factor on your health and decision making ability.
These aren’t easy questions, but they’re essential. Put some thought and effort into coming up with the best answers possible, knowing that there are no right or wrong answers, there’s only true or false answers. You need to be brutally honest with yourself and make sure that your answers are a true reflection of your specific situation. There’s no room for self-deception in investing.
Investing always involves a degree of risk, and being truthful in your answers will help you to be more comfortable with that. In the game of investing, the only opponent you’re really up against is yourself.
Ok, now you know who you are, what you want and what you want it for. You will now start looking at your investing options so you can decide what to invest in and what strategy you will adopt. In order to make any decisions in your investment journey, there are a number of aspects you must consider and make sure you get right. I will leave that section to the end of the blog though and will start with a quick look at some of the different investment classes and tools you can use.
Asset Classes
Asset classes are in essence different categories of investments, each with their own unique characteristics. They tend to follow most of the same rules and regulations, but don’t necessarily dance to the same market tunes. This makes some of the asset classes uncorrelated to other asset classes.
You’ve got your equities (that’s your stocks), fixed income (think bonds), cash and cash equivalents, real estate, commodities, and then there are the alternative ones like art and cryptocurrencies. Each one comes with its own level of risk and potential for returns, and they all react differently to the market’s ups and downs.
Now, everybody and their grannys have heard of diversification. And we all know instinctively that diversification is all about not putting all our eggs in one basket. But you would be surprised by the number of people that think that they are well diversified by buying the S&P500 for instance, because it’s a basket with 500 stocks. Or, this is quite common in the crypto sphere, to buy 20 different tokens and believe that they’re diversified.
True diversification means to spread your investments across different asset classes, in order to reduce risk while upping your potential returns over time. You do this by investing in uncorrelated asset classes, not by investing in different assets within the same asset class.
With that out of the way, in this section we’re going to take a closer but brief look into six key asset classes: Bonds, Equities, Commodities, Real Estate, Art, and Cryptocurrencies. Sure, there are others like cash and cash equivalents, derivatives, and foreign currency, but we’re going to focus on these six. Why? Because I want to. — That felt good!
Bonds
You can think of these like IOUs or loans. When you buy a bond, you’re essentially lending money to the issuer, which could be a government or a corporation. In return, they promise to pay you a fixed interest over a certain period and return the principal when the bond matures. Bonds are generally considered safer than stocks, but the returns are typically lower. They’re a good choice if you’re looking for steady income and lower risk.
Equities
We all call them stocks don’t we? Some of you may be tempted to call me out here, since technically stocks and equities are slightly different, but if you know the difference, you should accept that it’s ok to do what I’m doing here.
Stocks are equities traded on stock exchanges. When you buy a stock, you’re buying a piece of a company. You become a shareholder, a part-owner of the business. Stocks have the potential for high returns, but they also come with higher risk. The value of a stock can go up or down, sometimes dramatically, based on the company’s performance, market sentiment, and broader economic factors. There are 2 main types of stocks. The ones that pay dividends and the ones that don’t. This key difference will impact your investment decision when investing in stocks.
Commodities
Commodities are physical goods like gold, oil, natural gas, agricultural products, and more. Investing in commodities can be a good way to hedge against inflation and diversify your portfolio. But remember, like any other asset, commodity prices can be volatile, influenced by supply and demand dynamics, geopolitical events, and even weather patterns.
Real Estate
I’m sure you don’t need me to explain this one to you. But here it goes anyway. You invest in real estate by buying property, whether it’s residential (like houses and apartments), commercial (like office buildings and shopping centres), or industrial (like warehouses and factories). Real estate can provide a steady income stream (through rent) and potential appreciation over time. There are actually a few different ways to generate a return on investment with real estate but keep in mind that this type of investment requires more hands-on management than stocks or bonds, and the entry costs can be high.
Art
Art as an investment? Absolutely! Art can appreciate in value over time, and it’s a great way to diversify your portfolio. But investing in art requires a deep understanding of the art market, and the entry costs can be high. Although we already have solutions that provide the possibility to buy fractionalised art, or “shares” of a specific piece of art, through companies like MasterWorks. But, unlike stocks or bonds, art doesn’t provide any income until you sell it.
Cryptocurrencies
Last but not least, and not a surprise if you know anything about me, we have cryptocurrencies. These digital assets, like Bitcoin and Ethereum, although not as uncorrelated as most of us in this world would like, are a unique beast of an asset class in its own right. Yes, it’s quite young, not even 14 years of existence yet, but any money manager worth its salt, will agree that it’s an asset class.
Cryptocurrencies offer the potential for very high returns, but they’re also highly volatile and risky. And the regulatory environment for cryptocurrencies is still evolving, which adds another layer of uncertainty and uneasiness with some investors. Not to mention that most serious investors tend to be older people for all the obvious reasons, particularly the amount of money they can put at risk. And older people, in general, find it more difficult to understand what cryptocurrencies are all about. I’m not going to explain it here, but I’m happy I can include it in this section as an asset class.
Tools of the trade
In the realm of investing, having the right tools at your disposal and knowing how to use them can significantly enhance your ability to make informed decisions and effectively manage your investments. These tools aren’t just about brokerage accounts or software; they also include various investment vehicles and strategies that can help you optimise your returns and manage risk. Here are some of the most crucial tools you may want to consider for your investment strategy:
Brokerage Accounts
Think of a brokerage account as your gateway to the financial markets. It’s the platform that allows you to buy and sell a variety of investments, including but not limited to stocks, bonds, and mutual funds. There’s a plethora of brokerage firms to choose from, each offering its own unique set of features, fees, and investment options. Some of the more popular ones include Vanguard, Fidelity, Charles Schwab, and Robinhood. Degiro seems to be growing in Europe.
Crypto Exchanges
In the dynamic universe of cryptocurrency investing, Centralised Exchanges (CEX) and Decentralised Exchanges (DEX) hold pivotal roles. There are also other non-custodial exchanges that, even though not as popular, provide an invaluable service.
CEXs, such as Binance, Coinbase, and Kraken, operate in a manner akin to traditional stock exchanges. They act as the middlemen, smoothing the path for transactions between buyers and sellers. These platforms offer an intuitive interface, a broad spectrum of cryptocurrencies for trading, and additional services like spot trading, futures, and staking. However, a word of caution: CEXs require users to entrust their funds to the platform, which could potentially open them up to vulnerabilities.
On the flip side, we have DEXs like Uniswap or SushiSwap, which march to a different beat. They operate devoid of any central authority. These exchanges harness the power of smart contracts on blockchain networks to enable direct peer-to-peer transactions. A significant advantage of DEXs is the enhanced privacy and control they offer, as users maintain custody over their assets. However, it’s worth noting that DEXs can be a tad more intricate to use and may offer a narrower range of trading options compared to CEXs. Also, these DEXs can only be used to trade tokens that live on the blockchain the DEX is deployed to. So for instance you can’t buy Bitcoin on Uniswap since that DEX lives on the Ethereum blockchain. You can buy a synthetic version of Bitcoin that it’s pegged to its price but I don’t want to delve into the specifics of it, including its risks.
Another area I won’t delve into but will make a note of, is the emergence of bridges and blockchain interoperability platforms which will allow DEXs to trade assets native to other blockchains.
Other non-custodial exchanges provide the possibility to buy and sell different crypto assets from different blockchains and without providing KYC or putting your crypto in the exchange. So just like DEXs, you keep control of your crypto until you accept a sale,
The decision to opt for a certain type of exchange boils down to your personal needs and comfort level. If you value convenience and a wide array of services, a CEX might be your cup of tea. Conversely, if you place a premium on privacy and retaining control over your assets, a DEX or non-custodial might be more up your alley.
As always, it’s imperative to do your homework, conducting thorough research and understanding the risks associated with each type of platform before making your decision.
Investment Research Platforms
Investment research platforms are treasure troves of information designed to assist you in making informed investment decisions. These platforms offer data on a variety of asset classes, up-to-date market news, financial statements of companies, and analytical tools to help you dissect investment opportunities. Bloomberg and Morningstar are examples of such platforms.
There’s also financial media and news that provide information on market trends, economic indicators and company news. But be aware that if a piece of information is being shared in the mainstream media, it usually means that you’re already late on that trend. Think about it, who’s coming after you to take advantage of that information? If it’s in the mainstream media, it means that everyone now knows about it. A lot of the leverage investors have that lead to great investments, is the ability of being early into an idea. The later you are, the lower the probability of it being a successful investment. There are exceptions, but they’re just that.
Another great tool to get very relevant and valuable information that you can use to inform your investment decisions, is Twitter. Yes, the blue bird has some of the best investors in the world sharing highly valuable insights, for the really low price of… FREE. There’s a huge but here… and we’ll cover it later in this blog.
Portfolio Management Software
Portfolio management software is a tool that helps you keep track of your investments, analyse your portfolio’s performance, and make necessary adjustments. These tools can provide valuable insights into how your investments are performing, identify trends, and help you stay aligned with your investment goals. Personal Capital and Mint are examples of such software.
Some investment vehicles you should be aware of:
Exchange-Traded Funds (ETFs)
ETFs are investment funds traded on stock exchanges, much like individual stocks. They are designed to track the performance of a specific index, sector, commodity, or asset class. ETFs offer a way for investors to diversify their portfolios within an asset class, without having to buy each individual security within an index or sector.
Mutual Funds
Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other assets. They are managed by professional fund managers and offer a way for investors to gain exposure to a wide range of securities.
Real Estate Investment Trusts (REITs)
REITs are companies that own, operate, or finance income-generating real estate. They offer a way for individual investors to earn dividends from real estate investments without having to buy, manage, or finance any properties themselves.
Bond Ladders
This is a strategy of managing fixed-income investments by owning several bonds with different maturity dates. This way, the investor can manage interest rate risk and reinvestment risk because the bonds mature at different times.
These next 2 tools are commonly thought of as traders tools but they’re definitely used by investors as well, in their investment strategies. Both these tools involve much higher risks compared to the traditional tools we have looked at, so it goes without saying that you really need to know what you’re doing when you decide to use these following instruments.
Options
Options are financial derivatives that give buyers the right, but not the obligation, to buy or sell an asset at a predetermined price within a specific timeframe. They can be used for various purposes, including hedging against price fluctuations, generating income, and speculating on market movements. Options can add flexibility to your portfolio, but they also come with their own set of risks and complexities.
Leverage
Leverage involves using borrowed money to amplify potential returns. In the context of investing, this could mean using margin accounts to borrow money from a broker to purchase securities. While leverage can magnify gains, it can also amplify losses, making it a double-edged sword that should be used with caution.
There are more investment vehicles and tools left out of this section than there are included. But this should give you a good idea of the many different approaches one can take to investing.
Investment Styles
There are many investing styles. Some focus on the present value or growth potential of companies. But there are also macro investors or more technical investors who approach investing from a different perspective. Let’s take a closer look at these different styles.
Value Investing
Value investing is a strategy that has been championed by legendary investors such as Warren Buffett and Charlie Munger. This approach is all about finding stocks that are undervalued by the market. These are stocks that, according to the investor’s analysis, are trading for less than their intrinsic or book value. Value investors use fundamental analysis to evaluate the health of a company and identify stocks that are priced lower than their true worth. This strategy requires a contrarian mindset and a great deal of patience. It can often take years for the market to recognize a stock’s undervalued status and adjust its price accordingly.
Growth Investing
Growth investing is centred on the future potential of a company. These investors are interested in companies whose earnings are expected to grow at an above-average rate compared to other stocks in the market. Rather than focusing on the present, growth investors analyse future projections, such as forward earnings and sales multiples. Even if a company is currently unprofitable, the market often values it highly due to its future profitability potential, and these investors aim to capitalise on the momentum that comes with that narrative.
Although this strategy relies on fundamental analysis to make the investment decisions just like in value investment, it has a different focus and criteria to make those decisions. This style of investing is more subjective than value investing as it heavily relies on market sentiment and speculation.
Macro Investing
This is a completely different style of investing. The macro investor relies more on macroeconomic factors, global trends, and broad market analysis to make investment decisions. This type of investor takes a top-down approach, analysing factors such as interest rates, inflation, geopolitical events, and economic indicators to identify investment opportunities. They aim to capitalise on large-scale economic trends and shifts in global markets.
Unlike the value and growth investors who primarily focus on individual companies, the macro investor takes a broader perspective, considering the overall economic climate and its impact on various asset classes.
This style of investing requires a deep understanding of macroeconomics, global markets, and the interplay between different factors that influence investment performance.
Technical investing
This style of investing relies exclusively on technical analysis and doesn’t really care much about the asset. These investors think more along the lines of, show me the chart and I’ll tell you the news.
The technical investor is a unique breed, caring little for the specifics of the asset in question. Their focus is laser-sharp, honed in on the intricate art of technical analysis. For them, the story told by the chart speaks volumes, acting as a mystical oracle revealing hidden truths. They dismiss the news, for their trust is placed in the visual patterns and indicators etched upon the graph.
The key differences between this type of investor and a trader are the time horizon and trading strategy.
Investors typically have a longer time horizon compared to traders, focusing on the long-term potential of their investments.
Traders, on the other hand, engage in shorter-term trading with more frequent buying and selling. Another distinction is that traders often utilise short-selling, where they bet on price declines and profit from downward movements in the market, whilst investors, including technical investors, primarily focus on long positions, seeking price appreciation and holding investments over an extended period.
While both these 2 market players rely on technical analysis for their strategy, for the trader, all that matters is how and where the price is moving; the price itself is irrelevant.
I hope this gives you a better understanding of some of the key players in the market. I left out some very important players but those players usually fall into one of these categories. I’m thinking of institutional investors and money managers. There are also the market makers which play an important role in the markets but are more impactful for traders. Lastly, we mentioned traders but didn’t go into depth since this piece is focused on investing, but traders can have a meaningful impact on investment strategies and the only way to understand what the markets are going through is to study what traders are thinking. One can only do that by studying the charts.
Another way to understand what the markets are going through is to understand the market cycles.
Investing and the Market Cycles
The business cycle, also known as the economic cycle, refers to the rise and fall of economic growth that occurs over time and because it impacts the markets, it’s used as a tool for investors to anticipate and understand trends in various economic environments.
But the market cycles are a different beast altogether and arguably much more difficult to influence than the business cycles. Market cycles are driven by a complex mix of factors, including economic realities, investor sentiment, and broader societal trends.
Grasping the ins and outs of market cycles is an indispensable part of investing. These cycles, which consist of periods of market growth (known as bull markets) and periods of decline (or bear markets) have distinctive phases that can provide invaluable insights into the market’s current state.
The four primary phases of a market cycle are accumulation, markup, distribution, and markdown.
Accumulation: This initial phase is when astute investors start to buy into the market, often when sentiment is negative and prices are low.
Markup: As more investors catch onto the trends and start to invest, the market begins its upward trajectory.
Distribution: After a sustained period of growth, savvy investors begin to sell their holdings to retail investors. This phase often unfolds amid a market frenzy.
Markdown: When the force of selling outweighs the force of buying, the market enters a decline, known as a bear market.
Here’s a graph, courtesy of WallStreet Mojo.
Identifying the specific phase of the market cycle we’re in can be challenging but is crucial for making informed investment decisions. It requires careful analysis of market trends, economic indicators, trading charts, and investor sentiment.
Each phase of the market cycle presents its unique set of considerations. For instance, the accumulation and markup stages are typically seen as the optimal times to invest, as this is when prices are on the rise. Conversely, the distribution and markdown phases require caution, as this is when prices are falling.
You may be tempted to think that since you’re investing for the long term and not trading, you don’t really need to be worried about understanding at what stage of the market you’re in when you decide to invest, but that would be a mistake. To invest at the height of a bull market may mean years of waiting until break even and most times it means selling lower and taking a loss. Conversely, buying at the lows of a bear market may mean a couple of months waiting for outsized returns.
Ultimately, you want to make sure you’re making as much of an informed decision as possible, which is a great segway for the next section; crafting an investment process.
Crafting Your Investment Process
What do I mean by crafting your investment process? Nothing more than creating a framework or blueprint to guide your investments. You want to define a set of parameters that will guide your decision making.
Let me make it very clear. There’s no right or wrong approach to this. There is only right or wrong for you, for your particular situation. What I mean by this is that an approach that’s right for me may be wrong for you. If you have done the test in this blog, you will know what type of investor you are (or not an investor at all but a trader rather). If you’re a trader, you’ll find it very difficult to force yourself to behave as an investor and vice-versa.
The guidelines you will define need to be a reflection and aligned to your investor avatar. You will consider your risk appetite, investment timeline, financial aspirations and level of knowledge of the domain (asset classes and tools/investment vehicles). A well thought out framework is instrumental in maintaining focus and resilience, particularly during market turbulence or when your investments are not hitting the mark. Patience is a virtue that holds immense significance in the investment world, and a well-defined framework acts as a safeguard against impulsive decisions. More on this in the next section.
Like I said, there’s no right or wrong approach, all you need is to be brutally honest with yourself on all your answers. No one can tell you what framework you should use but I can attempt to give you a couple of tips if you’re starting out. I’m assuming you have done your homework and have a good understanding of who you are as an investor, what you want and what you want it for.
First tip, and I think this is a crucial one, is to start small and simple and evolve with time. Start with the basics, like time horizon, acceptable volatility and risk appetite. This should be enough to inform you of the asset class or classes you should focus on.
Start small with your investment capital as well. This is true even for more experienced investors. When you decide to invest in an asset, don’t go all in. Put in a small amount of the capital you have allocated for that investment. After a week or two, if you’re still happy and comfortable with your decision, add a bit more to it. Continue doing this until you have deployed all the capital you had allocated to that investment. Start as small as 1 to 5% of the total amount and increase the percentage as you go along and your conviction stays the same or increases.
Cut your losses soon and emotionlessly. This is way easier said than done but it’s achievable. You only need 2 things. First you need a trigger that tells you your idea is probably wrong, this is usually a technical indicator or a significant change in the assets’ fundamentals. The second one is more challenging and it is to keep your emotions at bay when decision time arrives. Remember you can always get back on the trade. It’s not the end of the world to win a little bit less because you got out and back in, but it can very easily be the end of the world, when you don’t get out.
Think of cutting losses as capital preservation. Many inexperienced investors think only of the potential rewards, but the number one rule in investing is… you guessed it, capital preservation.
As you progress, learn and become more knowledgeable and experienced, you can start adding more advanced areas to your strategy, like other instruments and asset classes, and you can start increasing the size of your investments, always dependent on your available capital of course.
Another tip I would venture to provide you is to don’t be caught in the noise. Once you start investing, you invariably start paying attention to financial news and every information you come across that can in some way shape or form have an impact on your investments.
Remember, what is a great opportunity for someone else is not necessarily a great opportunity for you. Do they have the same time horizon as you? They may be investing with a three month time horizon and you have a 5 year one, or the other way around. Does that asset fit in your portfolio the same way it fits on theirs? Not unless you have the same portfolio, and it’s rarely the case. Do they have great knowledge and conviction? Do you have the same level of knowledge and conviction? If not, when things do not go according to plan, which is almost always the case, you will find yourself in a situation where you do not know what to do and probably panic and lose money.
You need to step back, zoom out, and never forget your thesis. You need to be very comfortable with who you are as an investor, your strategy and your thesis or idea. If you have conviction on your idea, then you will be able to ignore the noise, if not, you’ll be food for the sharks and whales out in the market.
Last tip would have to be to trade as little as possible. This is valid even if you’re a trader. Possibly more relevant if you’re a trader actually. Wait for your set up, for your idea to materialise. Sometimes your idea requires you to get into the trade straightaway and that’s fine, but this does not invalidate the tip I gave you earlier: start small and increase your exposure with time.
So, is your framework aligned to the stage of life you are on? If you’re over 50 don’t invest like if you’re 20 or 30.
What size is your portfolio? If you’re just starting out, got married recently and have 2 young children, you probably don’t want to invest like a 50 year old in terms of portfolio size; unless it’s something you actually can do (you have the runway and the extra money to do it).
Are you a fundamental, macro or technical investor? Where does your knowledge lie? What are your strengths? Or are you actually a trader, that has a very short time horizon, can handle high volatility and has good knowledge of technical analysis?
I’ll finish with this: Your process is unique to you and without one you’ll end up getting poor while helping those who are getting richer.
I hope this section helps you in preparing yourself to be a better investor. But that will hardly happen unless you understand how emotions and other seemingly unrelated facets of life impact your decision making ability, not just in investing, but this is the area we will focus on.
Emotions — The Invisible Hand in Investing
Your emotions — The market doesn’t care
Emotions play a pivotal role in the world of investing, often steering decisions in directions that may not be entirely rational. It’s crucial to understand that these emotional currents can sometimes cloud our judgement, leading us to make decisions that deviate from our investment strategy.
The key to successful investing lies not only in your knowledge and strategy but also in effectively managing your emotions, maintaining a clear head, and keeping testing your idea. Is your idea still valid? Do you still hold your conviction? If your idea has been invalidated, cut your losses straightaway. You know if your idea was invalidated if there’s a fundamental change to it or a technical indicator that you have defined has been triggered. Take your emotions out of the decision making.
Now, that’s not to say that you should ignore your emotions. No. You just don’t let your emotions impact your decisions, but you do listen to your emotions and try to leverage from the emotions you’re feeling. More often than not, you will do exactly the opposite of what your emotions are begging you to do. Easier said than done, but it’s what mints millionaires. And because we’re social creatures, you can be pretty sure that if you’re feeling those emotions, it’s very probable that a good share of the market participants are feeling it too. You want to leverage that, and that’s why you need to be comfortable being a contrarian and going against the crowd. Now, all this needs to be aligned with your process otherwise you will give it a rain check.
Market Sentiment — The Collective Emotional Pulse
The emotional undercurrents of the market, often referred to as market sentiment, is the collective emotional response of investors to market conditions. It’s a powerful force that can drive market trends and create opportunities for those who know how to navigate it.
Savvy investors can leverage market sentiment, using it as a compass to guide their investment decisions. You probably have heard before that markets are driven by greed and fear. Well that’s absolutely true and knowing it doesn’t make it less true and by no means will shield you from feeling it too. When you’re fearful, reason seems to be a very shy and low volume voice in your head. When you’re feeling greedy, reason seems to like to go on holidays and is nowhere to be seen. There’s a reason why I, and many others, will tell you, it’s easier said than done.
All you can do is be aware of that, have a proper framework and be fully committed to act according to your framework. No decision is made on the spot and without being filtered through your framework. I don’t care how good of an opportunity it seems (there’s a great opportunity every day) or how bad it looks (it’s never as bad as it feels). Stick to your process.
Be mindful thought, that while market sentiment can provide valuable insights, it should not be the sole driver of your investment decisions.
Other Factors Impacting Decision Making
Don’t let the heading fool you into thinking this is just an add-on to fill up space. This blog is quite long as is (let me know if you got to this stage and found it useful). The factors you’re about to read, will make or break your investing adventure. And they make or break any professional investor. In fact they do make some investors and then break them when they change one or more of these factors.
Investing is not just about understanding the markets; it’s also about understanding ourselves. Various personal factors do significantly influence our decision-making process in investing.
Lack of sleep: If you don’t get a good night’s sleep, your decision making will be impaired. The mistakes you will start to make will need other problems which also impact your decision making. We will look into some of those problems, but an obvious one is that you will start having even more difficulties sleeping due to the increase in problems you created. Now, I’m not talking about one or two bad nights with insomnia or whatever. I’m talking about a regular lack of good sleep. Also, some people need 7 to 8 hours of sleep, others need a bit less. I’m no health professional, but I’d say that anything under five and half hours is not good sleep.
Financial stress: This one is probably obvious. If you’re facing financial difficulties you should not be investing, and if you are, you are probably trading rather than investing. And due to your difficulties, you’re likely engaging in riskier strategies like leveraged trading. You’re basically feeding your financial difficulties and will probably lose the house and wife. If you’re having financial difficulties, do not trade or invest. Sort out the source of the stress and get into a comfortable position before you engage in this challenging activity.
Health issues: This one may not be as straightforward but here we go.
First the mental health issues as this one should actually be self explanatory. If you’re not of a sound, healthy mind, do not play this game. You’ll make bad decisions that will create other problems in your life, like financial stress. Lack of sleep can lead to mental health problems.
Then there’s physical health: if you’re sick you shouldn’t be focusing on anything else but your health. Physical health problems usually require medication that can impact your cognitive ability but not necessarily. It can also cause stress and anxiety just because you’re not at your best, but again, not necessarily. Your energy levels are probably low or depleted and your brain requires a lot of energy to function optimally. Again, if you’re sick, concentrate on getting better, not on investing.
Relationships: If you’re having marital issues or any issues with any significant relationship in your life, your decision making ability will be impaired. Also, you may fall into the trap of using your investment (or its potential outcome) to resolve your relationship issues. This is of course a mistake and will most probably lead you to make rushed decisions that usually work against you, creating you other problems that you didn’t have in the first place. Also, if you let your relationships interfere in your investing activity in any way shape or form, you’re just signing your death sentence. They want the best for you (I’m assuming that) but they don’t know what’s best for your investment strategy.
Substances: This is another one that should be self explanatory but it’s not always the case. And the number of traders and investors that ruin their their lives due to substance abuse or misuse is mind-boggling. You can check that for yourself if you want but your findings won’t invalidate what I’m about to share with you. Let’s start with the easier ones.
Drugs: I don’t care which drugs, I don’t even care if they’re legal and prescribed or illegal, whatever class they’re classified as. You do drugs, you make stupid mistakes. In investing, stupid mistakes can mean ruin, bankruptcy, game over. It goes without saying, you can’t control your emotions when you’re under the influence.
Alcohol: Same as drugs. I don’t care what beverage you’re drinking. Game over. Don’t ask me if a glass of wine at lunch is ok. Zero tolerance.
Food: I guess you weren’t expecting this one. Well, eat junk and you’ll feel like shit and cloud your mind. But that’s not just it, it impacts your health, your energy levels, and your sleep. Not to mention it’s a crappy lifestyle that will eventually impact on your physical appearance and let’s be honest, that can also impact on other areas like self-confidence and relationships.
In short, sound investing requires a sound mind.
Conclusion
Investing is an infinite game which you can learn to play and make a significant impact on your life. Since the rewards are financial and money is half of every transaction, you will be able to create opportunities that otherwise wouldn’t be possible. I’m not talking about just the financial rewards, although that is the case in some cases, not all. But I’m talking about the knowledge you will gain about life and the society we live in, as well as some very valuable skills, including a grasp of human psychology but more important, your own psychology. Believe me, you will get to know yourself much better when you start investing.
I really hope this blog will impact your investing journey positively and not make you think that this is too much and not for you. Unfortunately, you don’t have a choice. Our money is no longer a store of value, so if you want to save your economic production from today to the future, you will need to invest. Fortunately, this is not too much for you, if you start small and simple and start building on it.
ádh mór
