I started “investing” in the stock market over 10 years ago. It was essentially a game at that point, because I treated it as a roulette – assuming I can time the market and trading on whimsical ideas and hearsay more than anything else. I was curious and wanted to improve my understanding of the market. I am still a starter in the market – but in this blog looking to step back and reflect on key mistakes is important as it might lead to rules or thumb or other general improvements in my investing methodology. That is the intent of this blog. Ultimately, I would like this to be a record of what NOT to do.
|Theme||What it means||What Did I Learn|
|Not Defining the Thesis of a Particular investment||Tons of investments that I had done earlier were without any hypothesis or reason; It may have been based on Cramer, or because I believed that Oil was too low when I had not looked at any macro factors.|| Consider a number of questions before considering an investment: |
– Why am I buying this asset? What is the macro context?
– What is the risk and returns expectations? Am I buying this for a goal fulfillment?
-What is the position of this investment in overall asset allocation?
– What is the range of future outcomes?
– Under what conditions does it go up or down?
– What are the odds of going up or down? What outcomes do I think will occur?
– What is the probability that I am right?
– What does the consensus think?
– How does my expectation differ from consensus?
– How does the current price for the asset comport with the consensus view of the future and with mine?
– Is the consensus psychology too bullish or bearish?
– What will happen to the price if the consensus is right or if I am right?
– Why would you succeed?
– Why will others fail? Will others fail due to their time horizons or due to their flawed incentive systems or flawed assumptions?
|Not defining the time horizon||Is this a trade? E.g., SLV |
Should this be a longer term option? E.g., should I have sold Facebook, Apple, Amazon
|For stocks that are not trades and are investments – hold for longer. Once you sell its hard to re-purchase – may appear to be admitting a mistake. |
Think like an owner – did Sam Walton’s family sell Walmart
Every trade is an admittance of a mistake. Should you be trading anyways?
|Not Distinguishing Between Price and Value; No Margin of Safety||Many times it may appear that a stock is buy at all costs. Not looking for cigar-butt investments, or even investments with big margin of safety.||Index buying when its 20% down has wrked quite well for me – after that don’t sell. |
Many times it may appear that a stock is buy at all costs. Not looking for cigar-butt investments, or even investments with big margin of safety.
Margin of safety defined by Inverse of P/E + Dividend yield (adjusted for growth rates)
Use multiple filters –
|Not thinking about odds (and Market Cycle)||During the trade there is essentially only 2 types of push and pull – one is a risk mitigating voice that asks you to opt out, another is the voice of greed. If you really consider that you||During the trade there is essentially only 2 types of push and pull – one is a risk mitigating voice that asks you to opt out, another is the voice of greed. Being aware of the odds of up or down (whether identified through a survey based method or any kind of valuation analysis can give you a sense of when and how much to exit)|
|Not thinking about Momentum||Selling on a limit order does not make sense – typically if your sell limit order is high.||I know that superinvestors like Joel Greenblatt may not agree with momentum. But I think that given that bubbles work primarily based on crowd behavior (from Soros and Marks) – it appears that it may make sense for momentum approach should be important for the trade. Riding a bubble has given many a good trades.|
|Not building Risk Management||Lot of top grossing positions ended up in losses (like GLD/SLV)||This is an area where I need to work a bit more to understand since there are many approaches to manage risk (e.g., using options) However, the most basic approach can be using stop-loss especially in a profitable position. Not taking loss on trade idea and moving on.|
|Waiting on the Sidelines||Time in the market is > timing the market|
Dollar cost averaging
|If I consider the drags on my portfolio – it has been primarily waiting on the sidelines. Most of the time I have been too scared of getting into the market. However, I think the antidote to that fear is diversification and need to consider a well allocated diversification.|
|Not using multiple filters for entry||Use P/E and Dividend yield as well as a survey based analyst consensus method to make an entry into a position||There are 2 flavors: First to to look at basic P/E and dividend yield to figure out upside potential. Second, For making entry into a specific position it may make sense to develop an overall score by looking at how many analysts are recommending the stock (and looking at it across the brokerages since the subscriptions might be different)|
|Not understanding the exact instrument||Numerous times I have been burned by backwardation and contango in future instruments (e.g., Oil, commodity, vix)||Unless you understand the exact instrument and how it will respond to changes in market condition, it is out of your circle of competence. It may be a gamble vs. anything else. Stick to things you know vs. things you don’t.|
|Not relying on just Index funds||It is not possible to beat simple index funds in overall returns – rely on index funds as much as possible||Other investors are smart, well-informed and more computerized – need to look for an edge if you want to beat the market.|
I have tried for many years – but overall not sure if I would have beaten the index fund.
Overall, I have beaten it from Sharpe ratio perspective. But if I consider the time horizons it appears to be close to impossible to beat the index
|Having Concentrated positions||Having concentrated positions such as Oil in 2015-16 led to the most pain||Concentrated positions can make you rich but it can also make you poor. Understand the risks and odds. If the risks are high – commit to only what you can easily let go. Apply Kelly Criterion for identifying the position.|
Of course, I am aware that this list may or may not be right and may be just based on my experience which could be a super small subset of the overall principles. Also, rules do not work in investing. For any reader of this blog, you have to find your own truth as my truth may not work. However, hopefully, this list is more of a common sense approach that might be useful.