Are We There Yet?

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Every parent has heard this complaining question from the back seat of the car at one time or another.  Usually, it is a daily chorus as the family's summer road trip plays out.  Many times, the question is followed with another old standard, "Why is Daddy so crabby?"  Children just do not comprehend the distance and time involved in reaching vacation destinations.

Some investors approach their investments in a similar manner.  They fail to identify their destination and formulate a realistic time frame in which to reach it.  They forget to tailor specific methods of investing to specific goals.  For some, the goal is just making money.  There is nothing wrong with that.  Making money is a good goal; but then what?  Long term goals, such as meeting college tuition for the children or investing for a comfortable retirement, are best reached with long term investments.  Years of short term trading with its ups and downs is probably not an appropriate way to achieve retirement security.  The risk of suffering a crippling loss shortly before reaching retirement age is just too great.

In Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow discussed the interplay between goals, strategy and time as follows:

A prime ingredient in any investment strategy must be a considered time frame, which will be directly related to major, intermediate, or minor price objectives.  How long is one willing to wait in anticipation of an x percent move?  What happens to one's calculations if the stock moves the wrong way?  Should one sell automatically, regardless of time, if a goal is reached? or protect the position with puts?*

Once a person sets a goal and establishes the amount of time needed to achieve it,  the next step is to consider and adopt the appropriate investment strategy or philosophy.  The investor or trader needs to develop basic ideas on which their way of investing is based.  Aswath Damodaran, a Professor of Finance in the Stern School of Business at New York University summed this up in his book, Investment Philosophies, as follows:

An investment philosophy represents a set of core beliefs about how investors behave and how markets work.  To be a successful investor, you not only have to consider the evidence from the markets, but you also have to examine your own strengths and weaknesses to come up with an investment philosophy that best suits you.  Investors without core beliefs tend to wander from strategy to strategy, drawn by anecdotal evidence or recent success, creating transaction costs and incurring losses as a consequence.  Investors with clearly defined investment philosophies tend to be more consistent and disciplined in their investment choices.**

Although most of the advice given above would seem to apply to long term investors, traders also need a goal, a strategy and a time frame.  The most famous trader, Jesse Lauriston Livermore, followed the basic tenet of quickly selling losers and letting profits ride.  He had a strategy for identifying and selling stocks which were not performing to his standards:

Hope is the villain here and it has ruined millions of speculators over the course of time -- take your losses right away they are real whether you sell the stocks or not.

To put this in another way I have two stops in mind when I enter a trade I have a "PRICE STOP" and I have a "TIME STOP."  I will not stay with any trade more than a few points if it moves against me and I will not stay with a stock position for more than a few days if the stock does not perform as I expect it to perform.***

It would seem that he did not always follow his own advice.  Livermore is reputed to have made and lost four multimillion dollar fortunes over his forty year trading career.

Aimlessly wandering from place to place without a plan and a map is a recipe for a bad family vacation.  Likewise, aimlessly bouncing from one investment to another without a goal and a strategy is a recipe for financial disaster.

*  Excerpt from Rediscovering the Wheel: Contrary Thinking & Investment Strategy, Bradbury K. Thurlow, ©1981, published by Fraser Publishing Company, is used by permission of the current copyright holder

**  Excerpt from Investment Philosophies, Aswath Damodaran, ©2003, published by John Wiley & Sons, Inc., page 13

*** Excerpt from How to Trade in Stocks, Jesse Livermore, ©1940, updated edition in 2001 with comments from Richard Smitten, published by McGraw-Hill, page 108

Comments are always welcome.