Investing is simply a matter of buying a security (stock, bond, mutual fund, ETF, etc.) and selling it at a later date. If the value has increased, you have made money. If it goes down, you are unfortunately worth less.
It can be fun and exciting or frustrating and exasperating. But it is very easy to do improperly, especially if you have a goal, a later need for your money. This can be your comfortable retirement, college tuition for a child or philanthropic interests that you enjoy.
Many people think that this effort is all about the price and change in price of the security that they purchase. They can follow an analyst’s recommendation, believe in the story a company has for its future or follow a hot tip overheard at a coffee shop. Actually, it is much more than that. But, it is not that complicated. The factors to be considered are not that many, but to be successful, you should be aware of them.
First of all, your investment choices should have a consistent rational behind their selection. That is why a plan, a set of rules, as to what to buy, how much to buy, when to buy it and when to sell it is important. The key is “how well would this set of rules have worked in the past?”
Without this plan, investors commonly switch from one approach to another to another and do not produce consistent results. And that is the most important thing … producing predictable consistent results with your approach.
One of the best ways to measure this is to ask “what is the Expectancy of this system?” The short definition of Expectancy is on the average, what percentage should I “expect” for each trade that I make with this system. If your system supplier, assuming you are buying one, can not answer that question, I would consider continuing my search.
You are probably thinking that you have heard “Past performance is no guarantee of future results”. And that is true; there are no guarantees in investing. But if your approach would not have worked in the past, what would make you think that it will suddenly work in the future. Plus past performance also gives you guideposts to know if your approach is no longer in synch with the current market. If it isn’t, then you can make adjustments to the system to bring performance back in line.
This review of the past performance of your trading approach is usually called backtesting. It is best done over a long enough period where the rules are tested against both up and down markets. For example, a system that performed well in the late nineties when the market seem to go up forever would not have done so well when the dot com bubble burst in 2000.
What factors should this set of rules consider? First, in what investment sand box are you going to play? A regular brokerage account, taxable or IRA, has a myriad of choices for you. However, a 401k or a 403b type plan usually has a small, predefined set of investments available to you.
Second, how are you going to know when your rules tell you to buy or sell a particular investment? You need a timely mechanism that will guide you here.
Third, does your system perform? Are the gains enough to meet your goals? Are the inevitable market pullbacks small enough that you will not abandon your trading system when your account makes a temporary decline?
Fourth, how does your system manage market risk? Many investors think that performance gains are the most critical factor when considering an investment system. In reality, the management of risk should be the first factor considered. You must be able to live with the risk involved with your approach. Then you take the gains that the market gives you consistent with that level of risk. Otherwise, you will abandon your trading system when you go beyond your risk tolerance. The best rule here is “can I sleep at night at this given risk level”?
Fifth, do you do this yourself. Do you have both the time and the interest? Or do you subscribe to a service that will notify you when it is time to act? Or do you have a third party manage your account for you. Quite often, having the requisite time is the most limiting factor an investor faces.
Sixth, what is the frequency of trading that your system calls for? Do you have to sit in front of your computer all day to catch the signal to trade? Or do you need to review the market every night, every weekend, every month? How does that fit with the rest of your life? Can you commit to be disciplined enough to follow the time requirements?
So, as an overview, that’s all you need to pay attention to. Granted, there are books that can be written about each of the points above. But, they don’t need to be. It can be as simple or as complicated as you want it to be.
The main thing is that to increase your chances of success in the investment arena, you cannot ignore any of the points above. They must be in alignment with your time, your commitment and your lifestyle.