To Succeed in Investing, Don’t Become Fixated by Your Own Success

What follows is a true and factual story. A University in the US did an experiment to understand more about the psychology of success. This experiment has subsequently been repeated a number of times at different places and by different people.

The experiment is straight forward. It asked people to guess the outcome of tossing a coin. The outcomes are either heads or tails and you guess the outcome and then you are either right or wrong.

On probability, if the coin is tossed you have a 50% chance of guessing correctly which way it will end up. The experiment required 500 tosses of the coin and the outcome followed the laws of probability of around half of the tosses producing a correct guess. This probability outcome is fairly well understood by the experiment subjects, and people generally.

However, within the 500 tosses you will have a good chance of stringing together a number of tosses in a row that you will guess correctly. This is where the psychology of success comes into effect. The experiment asked it’s subjects how they felt about their performance in tossing the coin and guessing the correct outcome at various times during the experiment.

What the experimenters discovered was that when people were having successful runs – four or five or six correct guesses in a row – they developed a belief that their own skill and expertise was responsible for this success. Reasons stated included: I am now concentrating harder and that is improving my performance, I am getting better at this; through to, I have developed the skill of how to guess a coin toss more accurately.

Remebering that the experiment subjects were fully aware of the law of probability at work in the experiment, with a likelihood of 50% of the outcomes being correct and 50% of the outcomes being incorrect, but believed that their talent and/or ability was attributing to their success. Quite disturbing in its contradiction.

Yet this happens with people investing in the stock market all the time – especially people new to investing and trading. After a winning trade or two or three, the investor or trader begins to believe that they have a special “talent” for stocks and shares. They begin to believe that they are naturally better than the average trader.

The outcome, before too long, is that the investor’s belief in their own ability results in over confidence. This over confidence results in trading too many stocks or trading without managing the risk inherent in any trade. Unfortunately the stock market has a nasty habit of slapping down over confident traders with a big loss.

So remember, every trade you take has risk which you need to manage. If you manage your risks and enjoy the chance string of winning trades from time-to-time you will be successful and you will avoid the Market Slap!

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Making Money from Share Trading and Investing Through Using Stop Losses

A stop loss is a pre-determined price that we use as the trigger to sell out of a losing trade. If the share price falls instead of rising then we sell and we sell at a pre-determined price to ensure that we minimise losses. We need to have a stop loss price because not all trades succeed – some fail. Even the best trading techniques struggle to deliver a success rate of more than 70%. Therefore even using some of the best trading techniques we will still end up with two or three losing trades out of every ten. For these losing trades we must keep our losses really really small.

Another way of thinking about share trading is that any trade can only have one of five possible outcomes:

A small profit.

A large profit.

A small loss.

A small profit.

A small loss.

That’s it. Five possible outcomes, no more, no less. If you could eliminate one of these five outcomes, which one would you choose? That’s right – the large loss. If you eliminate the large loss you are only left with the other four possible outcomes. If our small losses, breakeven trades and small profits even out over a period of time you will only be left with the occasional large profit, a rather pleasing outcome.

By now you should be in no doubt about the wisdom of eliminating large losses. The Stop Loss is what we use in every trade in order to eliminate any large losses.

We use a Stop Loss Rule. The stop loss rule has three parts to it:

1. With every single trade that you do you must have a Stop Loss in place.

2. Your Stop Loss price is set at the level where your loss will be 2% of total trading capital.

3. When your Stop Loss price is hit then you must sell. No ifs, no buts, no maybes. No waiting one more day/week/month/year until your trade turns into a “long term investment”.

For those who may be new to share trading the most difficult part of this rule is part 3. You must sell when your stop loss price is hit. It’s the most difficult part of the rule because it brings into play your emotions. Despite the huge emotional drag not to sell – you must sell. When your stop loss price is hit then you sell, no scond guessing. Following this simple and straight forward rule protects your hard earned cash.