Before you hand over your hard earned money to an online broker, read about this cautionary tale.
What’s a “go go investor”? It’s a term I coined for those new stock investors who get extremely excited about the prospects of entering the market and raking in the bucks, such that they chomp at the bit and start investing as soon as they have money available to them. I went through this phase when I first began my forays in the stock market a couple of decades ago. Fresh out of college and finally earning an income, I had savings I was eager to put to work, after learning that money can make you more money. Unfortunately, without the experience or even much knowledge to back me up, I immediately realized the hard way that stock market trading is not for novices.
These lessons hit home for me again when I read an eye-opening article from The Market Ticker, a new blog I follow. The article speaks of another blogger, a stock trader, who learned some grave lessons from playing the market rather aggressively. According to the stock trader’s story, he went from rags to riches and back to rags in a fairly short period of time: from $350,000 he zoomed up to an account worth $4 million based on some lucky moves. But unfortunately, he went through a “learning process” and switched from a short term trading strategy (possibly day trading?) to an intermediate trading strategy. But playing with $4 million in waters that are untested is a major gamble and a plan that’s begging to implode. And before long, the trader ended up losing his shirt.
Image by stockshaven.com
Why Is Stock Market Trading So Addictive?
So why do people do it? Why do so many of us highly rational investors decide to engage in stock market trading, willing to take that ultimate bet? It’s addicting in the same way that certain gambling activities are — it’s an activity that marries the elements of luck, quick decision making, certain “game” playing and analytical skills, strategy, and a vast repository of specialized knowledge. Not only is it fun and challenging, but it also affords you the promise of increasing your net worth at the same time, and if you excel at what you do, there’s a chance that you could become quite rich. And it’s easy enough for anyone to get started on — open an account with your favorite online broker and you’re off!
How To Keep Your Shirt On When You Time The Market
I’ve discussed the notion of stock market timing here in the past, where I provide my own stance on the subject. My advice is pretty much what The Market Ticker blog has offered: that you should limit any market timing and stock trading endeavors to a small amount of your portfolio. Here’s a quick summary of what you need to do if you’re plagued with the itch that befalls “go go” investors:
1. Learn the ropes on a virtual trading platform. If you’re set on making stock trades, then test the waters with some fake money. There are many free practice trading platforms you can use before you take the plunge with your hard earned bucks. You can open a free virtual trading account for fun and some profit: at some sites, you can even win money by joining stock trading games and investing contests, while learning how the market works.
2. Compartmentalize. Develop a “core and explore” portfolio. Your core investments are where you stick to sane, tried and true approaches to investing — here’s where you invest responsibly, even conservatively with long term goals in mind. Use mutual funds, index funds and diversification to grow your net worth. Approach stock market investing with reasonable expectations (keep the long term rate of return for equities in mind) and curb your urges to invest aggressively with your core assets. Subject these assets to a sensible asset allocation and keep to it! Then segregate and dedicate a section of your portfolio as funds for financial “exploration”. The “explore” part of your portfolio is what you can use to fund your financial experiments with.
3. Limit your more aggressive stock plays to a portion of your portfolio. We just discussed that portion of your portfolio that’s dedicated to exploring. To take it a step further, my recommendation is that you limit this money to an amount you can comfortably lose. This is the money you can afford to take greater risks with, so set a specific percentage of your assets as play money. My limit is 4% of my investment portfolio, while for some others, it’s as high as 20%. I believe that 20% of one’s portfolio is the absolute maximum anyone should designate as play money.
4. Don’t invest with emotion. I’ve said it before and I’ll say it again — if you’re feeling too much excitement, fear or greed (flashes of grandeur about how awesome a trader you are or how rich you’re going to get), chances are, you’re setting yourself up for stock market doom.
5. Never go on margin. Leverage is a tough thing to master in the stock market investing world. The Market Ticker recommends that you should never set yourself up for a margin call. My opinion? Just don’t go on margin unless you’re a trading master.
Copyright © 2009 The Digerati Life. All Rights Reserved.
{ 9 comments… read them below or add one }
Trading on a virtual platform is a great idea. I’m reading a book on options right now and there’s a great tip in there: keep a journal of your trades. Why you’re making this move, what your thoughts are, what your plans are if things go bad, etc.
This is the best “lesson keeper” of all: yourself and your own psychology when trading.
The stock market can for sure be intimidating, but you’ve laid out some good points to help take the edge off. WeSeed is nice because you can collaborate and learn from others by following their portfolios and moves. Number 4 is really important too. Investing with emotions will likely end with foolish decisions.
While I agree that trading platforms are a good tool, I have to say that I learned a lot more lessons when I had REAL money invested. It seems that you just care a whole lot more when you have something to gain or lose…
“Core and explore” – that’s a much more fun name for that strategy than ‘core and satellite’ term which we use here in the UK. Another day, another fun fact! 🙂
Trading with play money is good for a while, but ultimately real lessons can be learned only by real money.
I have a Zecco account that’s funded specifically for my “higher risk” stock purchases. I get 10 free trades each month, and use this account to buy stocks I hope to sell within a month. Zecco’s research tools aren’t as user friendly as Ameritrade’s, so I research on Ameritrade then buy with no commission at Zecco.
Play money can be useful to start out, but the only way to learn the ins-and-outs is putting real money on the line. Fake money losses can be shrugged off without too much attention paid, whereas you’re more likely to learn from mistakes when they cost you.
As the saying goes, Wall Street University charges a steep tuition. If you must trade stocks, by all means do it with a zero commission brokerage. But you need to be willing to devote a significant amount time to researching your potential stock picks. Yes, if you are good and can control your emotions, you can outperform the market, but if you’re bad or unlucky you can take a bath. I’m lazy so I just buy the entire market through indexes with a sprinkling of funds that I think will outperform the market over time. But the average investor has a 7% chance of picking a fund that will outperform the market over the long haul.
As it mentioned above: Play money is good for the start, to play or to test something. But good money can only be made by risking real money.