One of the most common mistakes I see in this industry is that investors do not have their end goal in mind (100%) before pulling the trigger on an investment. Having the objective in mind is crucial in that it gives your mind an exact target to aim for. Unfortunately many investors simply enter into a trade or investment and play the “wait and see” game. This mindset can be detrimental to one succeeding in this industry because emotions can become your enemy. Let me explain. When one adopts the “wait and see” game, and their respective position goes against them, investors can get twitchy fingers very quickly. Human nature never changes and this is especially witnessed in investing. Usually when concrete end goals are not cemented beforehand, emotions quickly come into the equation especially if positions are too large.
Here is my philosophy regarding the execution for any investment or trade in the stock market. One should have their position size down pat along with the maximum paper loss one is prepared to carry (stop loss). Furthermore one should have the the sale price also pinpointed so that profits can be taken when you believe they should be taken. Clarity is key. Nail that saying to your screen before you open a position. You will be amazed how better your trading becomes when you trade in this manner. Why? Because the only way you are going to make meaningful profits in the stock market is if you consistently take money out of the markets. This may go against what long term dividend growth investors recommend but it doesn’t really. Why? Because smart dividend investors also sell their holdings usually based off pay-out and earnings multiple ratios. Its the same thing. One doesn’t just have to sell on price. One can also sell based off fundamental metrics (be it sales or earnings multiples or free cash flow levels, etc) However the real issue here is that this should be decided beforehand to avoid your emotions getting involved which usually screws your position up.
Let me give you an example. A few months back, we sold a put spread in American Express (NYSE:AXP). I believe it was the $64-62 put spread that was expiring just before earnings. Anyways, the stock dropped to sub $60 before it announced its earnings and the put spread was looking at a max loss. However after doing sound fundamental analysis on this underlying, We really liked what we saw here. We were looking at a company with an earnings multiple that was cheaper that its average plus the recent appeals court decision (that sided with American Express) was also a big plus. Why? Because for the past few years, merchants had been trying to steer customers onto other cards just to benefit themselves and not the card holders. The court sided with the customers (and American Express of course) which in our opinion should have been bullish for the card company going forward. Many investors had thought that American Express would have gone into a slow decline after it lost the lucrative Costco (NYSE:COST) deal but in my opinion, it was dead right to walk away from the terms being offered at that time due to the low margins involved.
Many times in business and life, bad events can end up being a blessing in disguise. I knew American Express had been busy investing money aggressively plus also doing what it could to reduce costs. Therefore (before the put spread was put on which is a bullish trade), the end goal was to to either take profits at 50% or roll out to February/March if the spread went against us temporarily. Well that is exactly what we did here. We rolled out to March for a $0.25 credit and the position (once earnings was announced) came back to profit once we got our huge earnings rally.
What’s the moral of the story here? Look, market timing is the most difficult skill I believe to get right in the stock market and something we constantly struggle with. When we put on our position, we got our timing wrong as the spread temporarily went against us. However, the end goal was mapped out before we put on the trade. We take profits on the spread at 50% or we give ourselves more time to right by rolling out to early 2017. We had to go with option B but it payed off. If we had been in“wait and see” mode, I can assure you that we would have sold before earnings due to the risk binary events such as earnings present. “Start with the end in mind” and stick to this mindset. Your job is to make money from these underlyings. That’s all they are – numbers on a screen. Don’t fall in love with any of them. Develop your system. That in my opinion is how you create real leverage in the equity markets.