This is a syndicated repost published with the permission of Money Morning. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.
A few weeks ago, I told you a story about a woman who took my advice and used it to overcome her fear of investing.
As it turns out, it was an incredibly popular column.
Reader Robert from Vancouver wrote:
Thanks Shah for trying to provide some financial education.
There is a real and urgent need to teach people at least the basics of investing, the economy, and business.
And I wholeheartedly agree.
That’s why I wanted to come back and build on the advice I originally gave you.
You see, once you make a decision to start investing, the next step is to make a commitment to become successful.
And today I’m going to show you how to make that next step…
To Be Successful, You Have to Put on Trades
In a nutshell, the advice I gave in my March 27 column was:
Start by taking positions in companies you know something about. It doesn’t matter if you like or hate it. Just that you know enough about the company’s products, services, whatever they do, so the stock’s ups and downs make sense to you.
Once you pick a stock, you always start the same way. You put on the trade.
Never think that your trade, or your position, is an investment. It isn’t. It is a trade.
You can get out of it at any time.
If it turns into a brilliant pick, your trade will turn into an “investment” because it’s worth holding onto.
But to become a successful investor you have to start by putting on trades.
You can’t make money watching from the sidelines. But you also can’t be a deer in the headlights either. You can’t go into a trade and think it’s an investment and you’re stuck with it when it goes against you. It’s a trade!
And the reality is that some of your trades will be losers…
That means you will get out of positions with small losses. It’s part of the game. You will have some losses but they will be monumentally overwhelmed by the trades that will make great money. And the ones that keep going up and maybe pay you dividends will become the “core” of your investment portfolio.
And that’s your ultimate goal. You want to create an investment plan that leads to financial freedom.
Psychology and Perception Are More Important Than Data and Facts
One of the reasons I say that you don’t need to be an expert on any company, or on any stock, is that no matter how much homework you do, no matter how much analysis you do, what makes perfect sense on paper may have nothing to do with how your stock trades.
When you watch your stock going up and down, you begin to understand the “psychology” of other investors – what they’re looking at, how they interpret news and data.
You’re one person with one position. There are millions of people like you watching that same stock. Collectively, their perception of news and data and the psychology of their fear and greed ultimately motivate them to take action, which moves the stock.
I can’t tell you how many times I’ve done copious amounts of research and been absolutely confident that I was putting on a winning trade, only to have my head handed to me because other traders’ perception of something that came along (it could be out of nowhere) was interpreted as a reason to sell the stock.
My saying – and I live by this – is:
Money moves markets, but psychology moves money.
What I’m saying is: Go ahead and do your homework. But your knowledge of your stock, or your position, has to include your understanding about how other investors perceive the stock and its likelihood to go up or down.
Market psychology is everything. I can trade anything, any stock, any bond, any commodity, any derivative, anything, because I trade on OPP – Other People’s Psychology.
It’s not easy reading the market’s psychology, or the perception the market has about a stock’s prospects. But it’s not hard either.
First of all, understand that there are two ways to trade psychology.
You go with the flow.
You go against the flow.
I do both, and quite successfully.
Going with the flow is all about the “trend.”
The Trend Is Your Friend
Live by that and you will make a lot of money.
In terms of market psychology I always look for the big picture first. What is the big trend? Is the market (we’re talking about stocks) in an uptrend or downtrend?
If it’s an uptrend I want to be buying stocks. If it’s a downtrend I want to be shorting.
Always go with the flow by trading within the big trends.
After all, if the market is going higher, why would you fight it? You don’t, you ride it.
Of course, there are nuances in following the big trend. The general market may be going higher but maybe the stock you want to buy falls in an industry that’s not going along with the big trend. You have to be careful about that.
That’s where going against the flow might come into play.
I make a lot of money following the trends and riding them. But, sometimes I go against the trend.
The reasons to go against the big trend start with the big trend. Maybe you see it stalling out. Maybe you think it’s about to turn around and go the other way. It’s at these junctures that going against the trend, in measured fashion, can be very profitable.
If I think the psychology has changed and the general market is turning bearish, but the market has still been holding onto its gains, such that I see selective selling, or profit-taking, I will put on a counter-trend position.
If you put on counter-trend positions at inflection points, meaning where the market seems like it could change, you aren’t taking a stupid risk. Instead, you are taking a shot that you can get ahead of the bigger shift in psychology.
What’s critical is that whenever you take a counter-trend position, you don’t “get married” to the position.
You’re going against the trend, which you don’t generally want to do. But because picking tops and bottoms can be extremely lucrative (and trying to do that exponentially ups your learning curve), it’s worth the risk. Again, you only do that when you think you sense a change in the trend.
If I take a counter-trend position and the trade starts out against me, I get out just as the big trend reconvenes its footing and continues. I will lose a little and move on.
Here’s another way to play a counter-trend within a bigger trend: Buy that stock you wanted to buy but didn’t because its industry group wasn’t following the big trend higher.
At some point, when I think that stock and its industry may be out of favor enough, I’d consider buying in. Why? Because if the big trend is still up and I think it’s strengthening, then buying an out-of-favor stock that has already gone down (but is a fundamentally good company, not some crazy stock) isn’t as risky as it seems.
And if you’ve done your homework and like the stock but have been surprised that it has gone down in a rising market, then you’ll know instinctively if it has gone down enough to make it a good “value” in the rising market. That’s not a risky position.
I can’t impress upon you enough that you know more than you think. You have to trust yourself. Use your own knowledge of how people react to gauge mass psychology, which sometimes is mass delusion. But that’s another lesson.
So, I’ll say it again. Tune yourself into the psychology of the market. The psychology of other traders and investors, of what they are reacting to, of their fear and greed.
Perception is reality when it comes to how money reacts.