Matteo8

Becoming a better investor by avoiding common mistakes

Education
FX:EURUSD   Euro / U.S. Dollar
The world of investing has often been compared as a loser’s game in amatorial tennis (Charles Ellis, 1975) where matches are won by making less unforced errors than your opponent. Rather than seeking winning and difficult shots as professional do - they also seldom make unforced mistakes - the best strategy would be to focus on making less mistakes i.e. winning by avoiding as many errors as possible. As the legendary investor, Charlie Munger, eloquently put it: “All I want to know is where I'm going to die so I'll never go there”.

It is in this spirit that I would like to highlight the common mistakes made by investors. In my career, I have noticed three enduring mistakes and identified ways to minimize their impact.

Mistake #1:Keeping losing position for too long and taking profits too quickly
It would be more rationale to sell losing trades to save the capital and to employ it in better alternatives. Taking losses early hurts but it guarantees your survival as losses tend to accumulate over time. By the time it takes to recoup your loss (if you are lucky) you might have missed other opportunities. Idle capital is a drag on performance. If you are on a winning trade with momentum, why do you need to cut the position? Let it run and sell later at higher prices when the expected future returns are low or when there are fundamental changes to your view.
Solution: Gradual close of the position to minimize regret risk. By selling or buying partially, you can better manage your emotions and start taking action to address idle capital in losing trades. For winning trades, you can take some profit off the table and keeping, albeit reduced, the exposure.

Mistakes #2: Over-Trading
Some people pretend to be investors while in reality they are behaving very similar to gamblers in a Casino. There is nothing wrong with gambling, luck is an inherent part of every trading strategy, but this could lead to a serious addiction problem alternating from states of euphoria and greed to misery and fear. On top of that, for every trade you face costs: commissions, spreads, impact and opportunity cost. Trying to win points by outsmarting others and being overactive does not bode well for investors. Perhaps the French philosopher Blaise Pascal was onto something when he said: “All of humanity's problems stem from man's inability to sit quietly in a room alone”
Solution: Have a plan with a clear time horizon, objectives, price targets and be patient. Do not check prices frequently and do set specific regular times for portfolio reviews. You could also put alerts on prices if needed. This will allow you to make better and balanced investment decisions rather reacting to the latest news at the expense of long-term benefits. Bear in mind that there is a lot of noise in the financial market with myriads of distractions. It is not easy at all to interpret things correctly and to keep focus on what really matters.

Mistakes #3: Focus too much on past performance.
Thinking in terms of what has been successful in the past has no guarantee of working in the future. The financial markets are ever changing and so are the correlation across asset classes. Markets are discounting mechanisms, normally from one to two years ahead of the economy.
Solution: consider multiple elements to improve your decision-making process: commissions, assumptions, opinions and the expected returns implied by the current prices. Above all, do lots of research!

I hope that by being aware of these mistakes, you can improve your investment returns.

Sincerely,
Matteo
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