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.
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.
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