Summary
Probably the best way to improve as an investor is to know what are the most common mistakes among traders and how to avoid them.
Being aware of these pitfalls and mistakes among investors will improve your portfolio performance.
Not having a clear time horizon, info over-load, lack of risk management and let emotions drive your decisions are the most common problems.
Do not underestimate those with experience. They usually know more than they tell, think more than talk and are more aware than you imagine.
"One of the basic rules of the universe is that nothing is perfect. Perfection simply does not exist". Neither in relationships with people, nor at work and much less in the investment industry.
Most of the mistakes you think you make in your investment decisions are common to all other stock traders. In this article I will summarize what I believe are the 5 most common mistakes and how to avoid them. This is the best way on how to improve as an investor.
The greatest investors of the last decades -Ray Dalio, Warren Buffet, Steve Cohen, Carl Icahn, George Soros among others- have demonstrated the ability to deal with all kinds of market situations, different economic cycles and very singular macro situations, each in their own investment style.
I. Having Unclear Time Horizon
The first mistake is not having a clear time horizon. A basic concept I will clarify is what different types of traders exists and for how long they hold a position, so you can identify yourself and know what type of strategy you are using and what kind of signals and information you should take into account.
- Scalpers: Trading in a few minutes. - Day Traders: Holding positions during the day without carrying open positions for next one. - Swing Traders: Holding positions that last for days or weeks. - Position Traders: More structural and long-term positioning.
Depending on the profile, the set of inputs you should analyze from the market vary -news, percentage variations, macro evolution, interest rates, volatility, etc.-. They really change whether you hold a position for a few minutes or for the next few months. Let's see:
For a scalper, the macro situation is meaningless because it does not give time to have an impact on his decisions, but for a long-term investor it is probably the most relevant issue and the one that most determines his decisions in the market. On the other hand, a data that comes out at 3pm such as Core CPI or New Homes Sales can be crucial for a scalper because it will have a great impact on the time that his positions last and can mean the success or failure of his operation, while for a long-term trader this data is just one more in a series that sets the direction and the cycle of the economy and financial markets in general.
Considering this, the clearest mistake when the time horizon is not clear is to want to analyze all the available information when in fact only the information that affects the decision making of your time horizon should matter. It has happened that a long-term investor, who initially wants to hold positions for 2 years and starts analyzing 5-minute charts and looks for divergences in the MACD and RSI in a chart that in less than an hour will be diluted and will no longer have any relevance.
All this information, if you let it have an impact, can make you take very specific decisions to avoid a correction (or a rebound) in the short term that fundamentally will not change the main trend of the time horizon you are operating and you will not make optimal decisions.
II. Changing your Opinion on a Regular Basis due to Over-information.
Let yourself be influenced by whatever you read and hear is the second big mistake investors make.
When you have too much information, you lose the perception of what is really relevant and blur your criteria to differentiate what can have an impact on your decisions and what cannot. It is as bad to receive TMI as it is to not listen at all. The middle point would be to not let yourself be influenced by everything else, have your own criteria developed and try to learn and be open-minded to other's opinions and know if what you are doing is correct or not, at least until doubts arises if you should rethink a strategy, positions, or interpret another possibility about the financial markets.
The crucial issue is to know how much to open/close the door so some noise comes in but it is not too distracting nor is it absolute silence. To overcome this, the main lesson is to follow people who you admire as investors and who are not all like-minded. If we take well-known investors such as Warren Buffet, Ray Dalio or Michael Burry, they all have different investment typology and that leads them to have different opinions about the markets.
III. Letting Emotions Drive your Decisions.
Also related to what I mentioned in the previous points. Both because you can be easily influenced by the market's noice and you can also easily confuse what kind of data is important for your type of investment and time horizon.
Frustration, greed, euphoria or fear. The most common quote you hear from new investors is "I got the market direction right but closed it too early for fear of losing what I was gaining". The analogous is "I let the position run too long and did not stoploss for fear of recognizing that the position was incorrect". The weight your reasoning must have should be superior to decisions taken by emotions.
As well as this simplified cycle of emotions, there are other biases that affect our decision-making processes in both strong and weak markets. Keep an eye out for some of the following that might be influencing your own investment behaviours:
Cognitive Dissonance
Conservatism
Confirmation Bias
Illusion of Control Bias
Regret Bias
IV. Lack of Risk Management.
Trading and investing, whether in the short or long term, is not only about having a 60-70-80% success rate, but also about good risk management of the portfolio as a whole. You can be right 90% of the time and lose money just as you can be right 30-40% of the time and earn it. The idea of the latter is when you get it right, try to maximize the gain and when you lose, control those losses properly. One of the big mistakes traders make is to focus too much on how many times you get it right instead of looking at the mathematical expectation of the trade. Investing and trading are an emotional roller coaster. Why is that? Because you are going to do something that is risky and risk your wealth, and it brings out all kinds of feelings. The risk of losing something is what blocks and makes one take wrong decisions.
V. Let Yourself be Influenced by the Others' Feelings.
Focus on people who have proven their value in the market not for 1-2 years but for decades will help you since you will be following professionals who will bring you value. Do not be influenced by everyone. Here is a humorous image that reflects very well what I am talking about and how positive and negative sentiments is transferred between investors.
Generally investor sentiment is a very bad indicator. What is the reason? The chart below reflects the relationship between the performance of the S&P500 monthly closes and investors' credit positioning. When the stock market is higher, investors are more invested and when there is a valley or recession and the stock market is at more attractive prices, they are less invested and even in surplus. When a market correction gets hot, stay cool.
Investors tend to be more bullish near highs and more bearish near the bottom. When the market is based on negativism, valleys are very short-lived because against complex economic situations there is monetary and fiscal policy to combat and the peaks can last a long time. Stimulus withdrawal is very slow compared to the abruptness with which they are activated. Adjust the model and listen to what your own practice and the evolution of your trading tells you. The more you want to earn, the more risk you have to take.
There are no freebies in the market.
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