Friday, September 18, 2009

Survival Kit For Newbie Investor - Greed And Fear

Last post we discussed golden rules for Stop Loss Order ( Now its time to discuss greed and fear. As a new investor you have to first clear your mind of greed and fear. It is easier said than done. Yet you need to constantly remind yourself not to be caught in this trap of greed and fear. I say it is difficult because of the fact that greed and fear are part of basic human nature. You have to toil hard to go against the grain of basic human nature, and that is why I am harping so much on this point. But once you can achieve this frame of mind then you will be able to avoid the catastrophic events of stock market. Hear out what William Gross has to say - "Markets invariably move to undervalued and overvalued extremes because human nature falls victim to greed and/or fear". By staying clear of greed and fear you will avoid the pain of regret as well as save yourself the pain of burning a hole in your pocket. Some of the golden rules are:-
  • Rule # 1. When faced with sure gains do not be risk-averse, while faced with sure loss do not become risk-taker.
  • Rule # 2. Beware of situations when high percentage of participants become overly optimistic or pessimistic of the future, it is a signal for the opposite scenario to occur.
  • Rule # 3. Never aim to enter or exit trade at exact market bottom or top. If you succeed to catch the exact market top/ bottom then you are lucky amongst millions, which most of us are actually not.
  • Rule # 4. Avoid entering trade in bubble situations and speculative runs. Sit on the sidelines till dust settles down.

There is a human tendency to give too much weight to recent experiences and extrapolate recent trends that are at divergence to statistical odds and rationale. That is how investors become more optimistic and aggressive in their trade when market goes up and more pessimistic than necessary when market goes down. Let greed and fear not grip you in such situations. Simply remember that what goes up has to come down, and vice versa. Laws of nature will ultimately govern everything in our lives and stock market is no exception. The legendary W D Gann gave utmost importance to the laws of nature and astrology while devising his super successful trading strategies in different markets. Later on in this series we shall also learn to pay our obeisance to the laws of nature.

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