What It Takes to Succeed in the Markets



When you boil it all the way down, investing is a game of "money" and "mind."  To succeed in the long run, you must understand this simple principle - and overcome these two primary obstacles.

The "money" part is fairly straightforward.  In a nutshell, more is better.  While it is possible to take a small amount of capital and build it and grow rich, the reality is that the more you have, the easier it is to make it grow. This is where the "mind" moves front and center. 

  • If you are "betting the rent money," the likelihood of reacting emotionally is much higher
  • Reacting emotionally when it comes to money is ALWAYS a mistake - even if things work out just fine "this time around" 
  • The mind remembers the exhilaration of a big money-making move and the pain of a fateful decision that costs you large sums of money
  • The mind instinctively craves more of the former and works hard to avoid the pain of the latter

The problem with the mind in investing is that there are so many ways to go wrong. If you invest long enough, there is a good chance that somewhere along the way, a trade you did not expect much from will play out gloriously, and you will almost not believe how easy it was to make so much. 

And therein lies the danger - the danger of seeking that feeling again and again:

  • After an "easy win," you may suddenly find yourself chasing opportunities or ideas that you normally would not - and probably should not - consider. 

At the far end of the danger scale lies the unexpectedly large loss:

  • This often involves a "self-inflicted wound" whereby an already bad situation is made even worse by throwing one's own rules or guidelines to the wind (ex., "I'll give it just a little more room before I get out" - right before the big overnight gap down, or some such scenario)
  • Even if you survive financially, there is long-term emotional danger, as the pain of that one bad trade can linger for years to come and actively trigger the "flight" response far too soon time and again
  • This can create a cycle of failure

There are ways around all of this, although nothing is ever completely foolproof. The first step is to have a plan:

  • Ironically, a well thought out investment plan is something that virtually every investor would agree they should have
  • Yet the truth is that only a tiny handful of investors ever really take the time to write out their investment plan

This is ironic - and quite sad - as such an effort can be empowering and can spell the difference between great financial success and average to below-average returns over the course of a lifetime.

The Keys to the Kingdom

The keys to investment success are to:

  • Develop a well thought out investment plan
  • Maintain the financial and emotional wherewithal to follow that plan

What should go into that plan? Let's delineate a few of the essential pieces:

  • How much capital are you going to commit in total?
  • What percentage of your capital will you commit to one individual position, and what percentage of that capital will you actually risk?
  • How many positions will you typically hold at one time, and what is the maximum number of positions you will hold at one time?
  • How will you decide how to allocate capital? Will you focus on large-cap, mid-cap, small-cap? Growth, value, low volatility, dividend payers? What about bonds, gold, and real estate? 
  • If you decide to invest in different asset classes, will you allocate a fixed percentage? Or will you focus on the trend of the relationships - i.e., allocate more to the best performing classes? 
  • What will cause you to a) enter a position, b) exit a position with a profit, and c) exit a position with a loss?
  • What about the tax implications? 

There are two parts to the bottom line:

  • An investor who actually takes the time to even think about specific answers to the questions above - let alone actually write it all out - gives him or herself a higher probability of long-term success
  • Most investors will never go through this exercise

Dealing with "Money"

The emotional pressure associated with investing "rent money" is great and often leads directly to mistakes and failure. 

One of the great ironies of investing is that:

  • The fear of losing money that you cannot afford to lose is typically a catalyst for actually losing money.

So before investing - and every once in a while along the way - you should take the time to consider how best to minimize your living expenses and maximize your savings to have as much money as possible to commit to investments: 

  • This is not to imply that you should "live like a miser"
  • It simply means that some serious consideration should be given to the tradeoff between "lifestyle and material things" versus having money available to invest and grow.  Remember, more is better.

In our day-to-day lives, we tend to focus on doing things (experiences) and having things (material possessions). The human mind instinctively wants as much of both as it can reasonably attain. But the other part of the equation is "peace of mind." Each event and acquisition that costs money comes with a withdrawal from the other side of the ledger. Again, there is no magic balance. It is simply to your own benefit to do some serious thinking about how best to balance experiences/things versus the peace of mind afforded by a realistic sense of financial security.

You might be surprised to learn how many millionaires use coupons at the grocery store.

Dealing with the "Mind"

Fear and greed are the eternal "Big Two" regarding obstacles standing between you and investment success. 

Investing typically involves a fair amount of ebb and flow, even for the very best investors. A lot of money is made, then some money is lost, then (hopefully) another big chunk of money is made, and so on. 

  • The trick is for the up moves to make more than the down moves lose
  • Unfortunately - human nature being what it is - an investor's emotions tend to rise and fall along with the equity swings

When things are good, the investment capital seems to grow at a rapid rate magically. And the more we make, the more we want to make even more, and the greater the urge to "get greedy." This urge can manifest itself in any variety of ways, but the most common typically involve:

  • Adopting a more bullish stance as things get more bullish, cavalierly ignoring the adage that "trees don't grow to the sky" 
  • Taking on ever-larger positions and committing more capital as prices rise

The net effect is being fully committed - financially and emotionally - when the top is reached

To appreciate this danger, consider the following:

  • If you are walking down the street and you trip and fall, that is one thing
  • If you are standing on a mountain top and you trip and fall, that is something entirely different
  • And if you don't even realize that you are standing on a mountain top - and your gaze is fixed to the sky above, wondering how much higher you can go - and you trip and fall, the only words that aptly apply are "look out below"

The bottom line: 

  • Do anything and everything you can to maximize gains
  • But recognize that NOTHING (especially a bull market) lasts forever
  • Respect the trend
  • DO NOT (ever) fall in love with the trend

On the flip side, when things go south, it is often a shock to the system. Stock market tops typically take time to form. This is when complacency sets in, and the typical investor waits patiently for the "next leg up." But when things go bad in the stock market, it tends to happen quickly. And just like that, all that money you had accumulated a week or a month ago is just a distant memory. Suddenly you are faced with a "fight or flight" dilemma:  Hold on and hope to make that money back or sell out and risk missing the next big advance. This is when answering the trading plan questions posed earlier serves an essential purpose. 

  • Emotional reactions cost you money in the long run - period
  • Maybe not every time, but in the long run, do not trust your gut to make intelligent decisions
  • Have a plan for how to handle risk and follow that plan

Set Reasonable Expectations

  • If your analysis suggests that somewhere along the way, your investment capital will experience, say, a 20% drawdown, then at the point the drawdown reaches 12% or 15%, the proper course of action may very well be to do absolutely nothing 
  • But also know that if the drawdown exceeds your expectations and things are going seriously wrong, you may be required to act instantly and decisively to mitigate a potentially devastating situation 
  • Another useful adage is "focus on the risk." If you take care of the risk (i.e., limit your losses), the market will take care of the gains

One last point to ponder - how much volatility can you realistically stomach? Putting aside strategies and investment vehicles and buy and sell criteria, in the end, the volatility of the fluctuations in the equity in your account may have a greater influence on your long-term investment success - and your peace of mind along the way - than any other factor. 

  • Roll too large, and you expose yourself to potentially devastating risk
  • Roll too small, and you never accumulate a fraction of what you might have had you been just a bit bolder

The battle for money is ultimately a battle of the mind. The keys to investment success are:

  • Form a plan that removes emotion from your investment decision-making process
  • Follow that plan

Same as it ever was.

The post titled What It Takes to Succeed in the Markets was originally published as on SentimenTrader.com on 2021-05-12.

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