Take Your Investing to the Next Level With These Two Tactics
When you embrace the fact that you can't forecast the future, you are better able to navigate market uncertainty.
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Wall Street views accurate predictions as the highest level of achievement. If you can accurately predict the future, then you are sure to be on the road to enormous wealth.
Maybe, but there are two problems. Many predictions are just luck, but they are confused with skill and create a false sense of competency. There is no bigger recipe for disaster than ego and overconfidence.
The second problem is that no one in the history of Wall Street has consistently predicted the future with a high level of precision. Many investors have made very big calls that turned out to be accurate, but no one does it consistently. Even the best investors on Wall Street are wrong a very large amount of the time.
Those investors who achieve great wealth aren't better at predicting the future. What they excel at is reacting to conditions as they change. They double down when conditions are good and the odds are in their favor. They go big when they have an edge, and that is how they make their money. It has little to do with predicting the future.
These investors are also very good at admitting mistakes. They escape quickly when things go bad, which keeps losses small and protects precious capital. If you keep losses small and accounts near highs, then the tremendous power of compounding will reward you.
There are two tactics that investors can embrace to put them in the company of investor greatness. The first is to react to market action rather than to try to predict it, and the second is to use an incremental approach of many partial buys and sells in various time frames when investing or trading. I will discuss the actual application of these two principles in great depth in future articles, but it is extremely important to understand the philosophy first. Why should you avoid making predictions, and why should you use a partial buy-and-sell approach?
The Futility of Prediction
The longer I've been in the market, the less confidence I have in predictions. Wall Street and the business media love predictions because they make for good stories. When Bob Blowhard predicts that the market is going to crash, it receives much coverage, but no one ever does any analysis of how often these sensationalistic predictions work out. Even when they are correct, the timing is never very precise.
Embracing the idea that you can't predict the future is extremely powerful. It allows you to react much quicker and to take advantage of what surprises might occur. When you are dogmatic about predicting the future, you have to overcome your built-in bias, and you will have to fight your inclination not to admit you are wrong.
I have no idea what the stock market is going to do next year, and I don't even want to try to predict. One of the staples of financial journalism, however, is to predict what will happen next year. Readers like that sort of information, because it gives them an illusion of control.
What I can predict about the market with absolute certainty is that there will be ups and downs, and if we react effectively, we will produce exceptional gains. It doesn't matter if the indexes finish the year higher or lower. It doesn't matter if there is a bear market or a bull market. It is reacting to the shifts that will produce big gains.
Why not just admit that we don't know what the future may hold rather than pretend that we have some special insight? When you stop playing this game of predicting the future, you are less likely to make emotional decisions. You watch for hard evidence that there is a change taking place, and you react to price action rather than try to guess what it might do in the future.
Stop worrying about what the market and your stocks might do in the future and focus on what they are doing right now. When things start to change, take action and stop wishing and hoping about the future.
Incremental Buying and Selling
If you embrace the idea that prediction is futile, then it makes sense to use the same thinking when you are actually buying and selling stocks. We never know if we are buying or selling at the exact perfect time, so why pretend that we are? The alternative is to handle your trades reactively as they develop.
Rather than make a single buy and sell, enter a trade with the idea that a good stock will perform over time, but we have no idea what the journey will look like. The stock may drop first, languish, or just take off, and we need to be in a position to react to each situation.
When I enter a trade, I am optimistic about it working, but I'm also prepared for the likelihood that it won't immediately turn into the greatest stock ever. I want to take advantage of the volatility that is sure to occur. When a stock drops after I buy it, then I want to view that as an opportunity unless there is something fundamental that has changed.
The partial buy and partial sell approach is the embodiment of the thinking that you can't make precise predictions. You never know how a stock will act, so rather than pretending that you can, it is better to react to conditions as they change by making partial buys and sells.
There is a host of considerations to keep in mind when using an incremental trading approach, but the first step is to recognize the philosophical basis for it. When you realize that stocks seldom will do what you hope they will do, then you are in a much better position to design effective trades. I want to always be in a position where I can view a drop in a stock as an opportunity rather than a disaster.
Many people view predictions as the heart and soul of the investing process. That thinking is reinforced by traditional Wall Street and many pundits who want you to be dependent on them. Success in the market is primarily a function of effective reaction, a clear trading strategy, and recognition that we don't know what the future may hold.
At the time of publication, DePorre had no position in any security mentioned.
