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There is no shortcut to successful investing. However, there is a process. It starts with you. More specifically, it starts with who you are on the inside. It took me a long time to learn that fact.
People look externally for the holy grail of investing. They will cite study X showing small stocks outperform overtime or study Y showing that value stocks outperform overtime. Market timing reduces risk, market timing is impossible, discounted cash flow is the best valuation metric, price to sales is the best valuation metric, low PE stocks outperform, low PE stocks under-perform... read enough of these articles and you won’t know what to believe. People ruthlessly bounce between renewed excitement and disappointment when it comes to an endless selection of investing strategies. In Trade Your Way to Financial Freedom,Van K. Tharp states, “almost every successful investor that I have encountered has realized the lesson of the Holy Grail metaphor -- that success in the markets comes from internal control. This is a radical change for most investors.” So before everything else, just relax! No one investing strategy has a monopoly on success. This is why William O’Neil and Ben Graham exist as models of supreme investors in the same universe even though their styles are very different. There is not an ultimate strategy that you will find if you just keep looking. In fact, you have to find the one that is right for YOU because YOU are the one implementing the strategy.
Your Mind as a Weapon
In Sell and Sell Short, Alexander Elder writes, “I want you to recognize the hugely important fact that your mind is a part of the decision making process. Your fears, wishes, and fantasies have a greater impact on your trading than all moving averages and trendlines combined. You have a great capacity for deluding yourself- but your success depends on seeing the truth.” Your mind is a weapon for you and against you. Both Elder and Tharp explicitly reference human error in terms of emotions clouding good judgment. Tharp even says that we do not trade the markets -- rather we are trade our beliefs about the markets. This is the primary reason you have to invest in a way that works with your values, beliefs, and emotional makeup. If you are trying to follow a proven growth or momentum strategy but you get nauseous every time you buy a stock making a new high, then you might not have the emotional fortitude to stick with the strategy consistently. More importantly you will probably end up making yourself miserable. The Fool is right that investing should be enjoyable. Find a style that you are comfortable with so that you can enjoy mastering it (something I'll speak more to below).
Your Style and Internal Control
If you've selected a style that you are comfortable with then you can better develop the internal control that Tharp argues is the key for all successful investors and traders. It consists of emotional control, patience, and discipline. You can establish internal control by consistently implementing a proven style/strategy/method that suits your temperament and mindset. Following the rules reinforces discipline, discipline reinforces following the rules…you get the picture. If you are good at growth investing, then pursue it and learn all its intricacies. If you are a deep value investor and know exactly what criteria you invest with, then do that repeatedly. Don’t flop around like a panicked fish straining for air. In Secrets for Profiting in Bull and Bear Markets, Stan Weinsten says, “Lesson number one is consistency! For over 25 years I have been consistent in my approach and discipline. This is so very important. Don’t be a fundamentalist one week, and a technician the next. And don’t follow indicator A one month and switch to indicator B the next. Find a good method, be disciplined, and stick with it. If it doesn’t regularly beat the market, then get a new method. But be absolutely disciplined and don’t ever abandon a successful method because you think this time things are different.” Find the right style, use it, develop internal control, and become consistent in your approach. Profits ebb and flow -- but your style should not.
Why Consistency Matters
A consistency of method helps you define how you identify opportunities in the market. Knowing exactly how you identify opportunities allows you to approach the market on your own terms. You know there is not a rush because you can always find other opportunities. Being able to approach the market on your terms will help you develop patience and discipline as you learn to trust yourself and your method. This is part of the reason so many of the Fool’s services are successful – they have a proven method that they use to approach the market and they stick to it.
Consistency in Time Leads to a Competitive Edge
The idea of mastering a focused strategy and consistently following it over a long period of time it is the only thing that is going to give you a competitive edge as an investor. Switching from strategy to strategy because nothing seems to be working is the surest recipe for failure. Nothing is working because you are not allowing any one strategy enough time to actually work! Consider what Howard Marks wrote in The Most Important Thing: “In investing, as in life, there are very few sure things. Values can evaporate, estimates can be wrong, circumstances can change and 'sure things' can fail. However, there are two concepts we can hold to with confidence: Rule number one: most things will prove to be cyclical. Rule number two: some of the greatest opportunities for gain and loss come when other people forget rule number one. Very few things move in a straight line.” No great strategy or style works all the time, but no great strategy or style fails to work at all. If it is a proven strategy, then have the patience and discipline to follow it overtime. This is what will provide a competitive edge.
The Take Away
The first key to successful investing is inside. Learn how your beliefs and emotions affect your investing decisions.
Spend less time endlessly searching through stock ideas and more time defining yourself and researching proven strategies/methods. Adopt the one(s) that align with your emotional make-up and worldview.
Consistently implement the proven strategy/method/style you select in order to develop expertise and emotional control. Stick with it over long periods of time.
Following these steps will give you three competitive edges over other investors in the goal of out-performance.
1. Gaining detailed experience with one method will help you expertly implement it.
2. Strictly following a method or style will give you the discipline to override rash emotional decisions. Who hasn’t panicked and sold at the bottom?
3. Almost all strategies proven to out-perform market averages have only done so over longer periods of time. Having the discipline to follow a strategy faithfully for long periods helps increase the probability of outperformance.