Beginner Investor Series – 10 Tips for Keeping Emotions out of Investing

Keep a Trader’s Journal – Keeping a trader’s journal is the first key to keeping emotions out of your investing. If you force yourself to write down why you are making a trade you suddenly become more accountable for your actions, even if only to yourself. A trader’s journal makes you take the time to think about each trade and do more analysis than “I hope this works”. In a downturn you can review your notes in your journal and see why you thought the now sliding stock was a good buy. If you still believe in what you wrote to yourself, you can remove the emotion and hold on to it. If the data has changed or your perspective has changed then you can exit the position without emotion. In writing a journal the decisions become black and white. Reviewing profitable trades will help you learn from what you’ve done right in the past instead of just thinking, “I got lucky on that one”.

Research – Knowing what you are buying is key to avoiding emotional set backs in investing is. A lot of small investors invest in a stock because they heard a tip from a friend that it was good or read one article that touted its virtues. Those sources have hopefully done their research for why the stock is good for them, but each individual investor needs to know why the stock is right for him or her. Without research writing in your trading journal emotions can beat out facts.

Chart – Charting a stock is probably the easiest way to remove emotion from investing. If you chart a stock you can pick an entry and exit point based on lines without creating any attachment to the letters that make up a stock’s symbol. For some reason lines draw in less emotions than letters. Write down your reasoning in your journal. For example if stock ABC finds support on a line drawn from its ever higher lows, then you know to buy at that point. If ABC closes below that trend line for two days, don’t wait, sell. One of the problems with charting is that you can use many different trend lines and moving averages in your analysis. To avoid redrawing lines and changing methodology, pick what seems to work for you and don’t change your mind to fit your mood of the day/week. Using every charting technique available can create a state of ‘trader freeze’ where you can always find a reason not to trade on a stock or worse ‘trader frenzy’ where you can always find a reason to trade on a stock.

Filter what you read – Headlines in newspapers and Internet sites often include flowery language to help the writer stir emotions in his readers. Learn to filter out the emotion invoking words and focus on what is important, the facts. Here are some examples:

Mortgage Applications Crawl Higher = Mortgage Applications Rose Some
Good Times for Time Warner = Time Warner Reported Better Than Expected Revenue, but Profit Fell
Citi, Stuck in a Swamp = Citigroup, Inc is Making Job Cuts to Lower Expenses

Know yourself – If daily ups and downs of the market turn your stomach, think longer-term and safer, less volatile stocks until you can accept that the market has down days. A lot of beginning investors jump in too deep before they have learned to accept the daily ups and downs of the markets (see Perspective below). Knowing what types of losses you can accept in a day, week, month or year is crucial to building a plan that works for you. I know for a fact that I am going to have months where I lose money. My goal is to limit those months. Knowing that I’m going to have the bad months allows me to stay invested for the good months and years. Accept loss and move on, it’s just money.

Perspective – I’m the kind of guy who doesn’t like to buy a Coke with my lunch because I don’t like to waste the money (and it’s not good for me, but that’s not my point here). I get mad if I buy Dockers when they aren’t on sale. I pay my bills on the last day before they are due to make sure I get that extra part of a penny of interest for keeping the $100 in my account a little longer instead of with the power company. If I see a penny I pick it up. That entire miserly attitude goes out of the window when I invest. I can lose $1,000 in one day on the market, but don’t fret because I know I’ll find a way to make it back and then some within my time horizons. I know that the market is going to move up or down every day. In fact, I’m fairly positive there has never been a day when the stock market was open that the prices of most equities didn’t fluctuate. To most of us small investors, the factors causing the market’s gyrations are unclear. What we should remember is to keep perspective. If we’ve done our homework by researching the company we are investing in and charting its stock price we can feel comfortable that we have made a wise decision.

Have an exit strategy – Before you buy, you need to know at what price you should sell. Unless you like being lost, you wouldn’t go on a vacation without knowing what your destination is. The same holds true for investing. Don’t start the trip unless you know where you will end. Of course you should write these ending points in pencil since new information can and should be added to the equation constantly. If your exit price changes, write it down to make sure you can say it’s not due to emotional changes.

Stocks are not our friends – Stocks are just letters that represent the value of a company. They are not someone you are asking out on a date or having over for dinner. If a stock does not treat you right, sell it. You can always feel comfortable thinking, “It’s you, not me” when dealing with a group of letters. The break up only takes a couple of clicks for an internet trade and you won’t run into each other at a friend’s house and feel awkward after selling. If you later like the letters, buy it again. The other stocks in your portfolio won’t be jealous.

Plan – I’m a project manager in real life. I like to plan and know what is supposed to happen next in my life, work and investing. Part of a plan has to be establishing a time frame. If I am managing a one month project I know that if I have one day that doesn’t go as planned the end date could be off by that much time. For a one year project I know that I can make up a one day set back later in the year. This same planning and considerations go into investing. If you know you will need the money in a short timeframe, don’t invest in risky, highly volatile investments. If you are planning for retirement and have a 20-30 year horizon you should welcome the dips in the market as opportunities to buy in cheaper.

Options – Selling options, specifically selling puts, can put this emotion-free strategy together in an easily executable tool. Before I go any further with this final point I need to warn that selling options can be very risky if you overextend yourself. For the risk averse I recommend only selling options for stocks you can afford to buy. This is only a simplified view of selling options. When an investor sells a put option on a stock she is selling the right to someone else to get her to buy that stock from them at a previously agreed upon price. That right to force a stock buy expires at some point. Those are three of our most important goals right there. The buy price is established (the option strike – possibly at a discount to the current price), the sell price is established (the premium received for the option) and the exit strategy is established (expiration of the option term).