We’re all here for different reasons. Each of us have our own time horizons. My risk tolerance is different than yours.
There are 3 questions every investor should answer before ever entering into a new position:
- Why am I here?
- What is my time horizon?
- How much am I willing to lose?
Let’s address each of these one by one:
First, the reason I’m even bringing this up is because they’re lessons that I’ve personally learned the hard way over many years. Unfortunately, I see people every day entering the market without first answering the questions above.
So why are you here? What is your primary reason for entering into the market? Are you investing for your retirement? Are you an Investment Advisor considering other people’s objectives? What are they? If it’s for your own personal portfolio, what is it for? A new house? An alternative to cash? There has to be a reason. And different accounts and/or strategies can have different objectives. I find it helpful, however, to have a bigger picture goal.
Be able to have an answer if someone in the market ever asks you, “What are you doing here?”
They won’t though. We don’t ask those kinds of questions. We’d rather ask, “What are you buying?”. That’s the wrong question.
What is your time horizon in the market? Are you a long-term investor saving for retirement? Are you a day trader? Are you trying to make money this month or this quarter? The time where you plan to make your money and have your edge has to be defined before entering an investment. How long do you plan on holding this for? A year? A decade? 15 minutes?
We all know the guy who entered into a “trade” because of some moving average crossover (or whatever silly indicator of choice) and then when it went against him he’s now listening to conference calls and ripping apart financial statements! Hell, most of us have been that guy or gal at some point. We won’t learn this one until it happens to us. That’s just part of the tuition we pay.
So how long are you trying to be in this investment. You have to answer that first and more importantly stick to it!
Finally, how much are you willing to lose? This is the most important of the three by far. In comparison, why you’re here in the first place and what is your time frame don’t even matter if you can’t get this one right. You’ll be gone soon anyway and the first two questions you answered won’t have to get answered anymore. Risk management is the most important thing here.
There has to be a level between where you buy something, and zero, where you admit defeat and move on. There has to be a level. And that price needs to be defined prior to getting involved in the first place. How much money are you willing to lose in the “off chance” that you are not correct.
If you think you’re going to be right on every trade, just pack your bags and go home now. You’re missing the point of what we’re doing. Think of it like a baseball player. If you lose 70% of the time as a batter you get inducted into the Baseball Hall of Fame. Just think about that. The greatest hitters of all time failed 70% of the time. They new that getting out was part of the game. Sometimes you pop up to left, other times you ground into a double play and sometimes you hit a grand slam. That’s just the way baseball is played. The market is no different.
Imagine if you’re playing for the Kansas City Royals and every time you strike out you kick and scream and yell and blame the president or the fed or ESPN and make a huge fuss over you swinging at a bad pitch? Could you imagine? That’s what twitter is like on a Tuesday. You should check it out some time.
My point is, we can talk technical analysis vs fundamental analysis vs economics or even lunar cycles. None of it matters if these 3 questions above aren’t answered. And the beauty is that all our answers are going to be different. And we can still get along and discuss with one another in a civilized way and be nice to people. This is crazy to some I know, but it’s true. We all don’t have to agree on everything all the time.
This is something that’s really important. Why are you here? What is your time horizon? And how much are you willing to lose?
Get those 3 right and I think that puts you way ahead of everyone else.