Bet Logical, Not Emotional

So many times we’ve heard these words, it becomes annoyingly redundant. Every analyst, every investor, even speculator, knows it well. The big firms say it over in their sleep and preach it to their younger colleagues. But what acts as the differential between the many who are “book-smart” to the few who are “street-smart”?

The rule is simple “Cut your losses early, and let you winners run”. This dictate is contrary to human psychology and why so many lose so much.

Recently, Steve Sjuggerud, wrote an article about a particular investor who got burned. What was his mistake? “I held when I should have sold and sold when I should have held”. Like in poker, investing is a game of discipline. Knowing when to hold ’em is of prime importance. It is said that any idiot could buy, but it takes a genius to sell profitably.

I came across a similar experience. A friend and I were discussing the market a few weeks back, as the Dow (and just about every other exchange on the planet) was recording new highs. I explained my concerns that the bull market was old and that I felt it would end badly for some and awfully for those who discounted this possibility. Sure enough, a few weeks later the Dow had just topped 14,000. Needless to say, I was “short”, but felt it unreasonable to mention my position.

My friend commented that he was a bit concerned but felt strongly that the market would bounce back. I felt that countering by how markets actually operate would be redundant, so I asked “Let’s say the market doesn’t come back. At what point would you sell?”

I thought my logic was reasonable. After all, if he was one of the “declines-don’t-matter-we’re-in-it-for-the-long-term” investors, there was nothing to discuss. However, if he was going to sell out when the “sailing got rough”, I simply wanted to know what was his definition of “rough” – a decline of 5%… 10%… 20%?

As the days went by he grew more and more anxious, and now expressed concerns as to when and how he would sell. He suggested that his best move would be to sell into strength. As the market moved slightly higher to cover its decline, selling into strength would get him out of harm’s way, as well as return some of his previous losses.

We met up recently. The market had come back somewhat. Did he sell? Nope. Emotion had gotten the best of him and he admitted it. He had taken his chances. Sure, we may see similar action like we saw in October 2005, July 2006 or March this past year. The market may be making new highs by New Years… and the bears will be laughed silly for yet another quarter.

But what if the bear market has begun, what if the losses aren’t recuperated and inflation rears its ugly head again? What if this credit fiasco turns out to be more than just a few bad loans? In either case, the investor that had chosen safety over greed, would have been content in either case. He would have done the next best thing the investor knows to do after making a fortune. Keeping it.

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