Relationship Investing

by Jeffrey S Weiss

  Some have opined that with so many folks looking at price charts these days, technical analysis has become a self-fulfilling prophecy. Wrong! Go back to the Great Depression years or elsewhere in market history. Similar chart formations have occurred over and over again over time not because of the increased frequency of chart usage but because investment behavior and the resulting supply-demand verdicts haven’t changed. Take a look at the historical charts and commentary in Technical Analysis of Stock Trends by Edwards & McGee. You’ll see what I mean. The book, now in its tenth edition, is considered a defining technical analysis work.

  Now consider fundamental analysis, where the same financial information for a particular company is viewed by analysts galore, yet their earnings per share estimates and investment recommendations for those shares may differ widely among them. In fact, the same stock can simultaneously carry a buy, hold, or sell rating depending on which analyst’s report you’re reading. It’s a similar situation with economic data releases, where despite analyzing the exact same information, economists’ growth forecasts, unemployment expectations, interest rate projections, and other prognostications surrounding the economy can vary visibly. This, in turn, leads to varying future forecasts for both the economic and investment landscape.

  No matter which investment discipline is used, the key is to find an approach that has the best chance of translating its respective analytical gauges into a successful investment outcome while simultaneously addressing the risk side of the investment equation. Investment success or failure is measured by the most important verdict the market can render: the share price. That’s what your portfolio value is based on. That’s how your stock market wealth is calculated. Period. The discipline that I sincerely believe addresses this reality best is none other than technical analysis. It looks directly at the action of the stock—no middle man, no diversions.

  Remember the game of “telephone” we used to play as kids, where someone would whisper a story into the ear of another and the story would pass from person to person down the line until the remaining person would reiterate the story as they perceived hearing it? You know what happened; the story had changed, often significantly, from its original version by the time the final person had related it. All too often in our business, we too can be diverted in the decision-making process by headline-grabbing news, events, and other external variables that come between us and our investments, causing us to alter our original decision. Not so with technical analysis.

  Book after book after book has been written on how to become a successful investor and gain the upper market hand. Numerous financial recipes with various formulas and methods have been offered. How so many folks can claim to have an avenue for investment success is beyond me. Some have wonderful academic credentials; others come from an information technology, engineering, analytical, accounting, scientific, or other background. But this much I can tell you: no matter which type of analytical method you settle upon, and what courses or books you decide to make use of in its study, it should include a healthy dose of technical analysis. For me, the analytical battle between technical and fundamental analysis was settled once and for all back in the 1970s in favor of the former.

  Moral: Living through the vicious bear market of 1973–1974 taught me that the most important consideration when investing isn’t how well you do on the upside; it’s how well you protect yourself on the downside when something goes against you, in order to preserve what you still have. The same thinking holds true in life: preserve what you have before trying to get more. I chose technical analysis because it’s a discipline that focuses directly on the investment itself and addresses this concern, bypassing the external noise of market opinions, news headlines, and other factors. The choice is yours. Mine was made more than forty years ago.

  Chapter 5

  Risk Management

  No investment approach is worth a look if it doesn’t address market risk. The business of investing in the stock market is one of the most humbling of all. After all, in how many businesses can you be correct nine times out of ten and still lose money? You can when investing in the stock market if that one loss swells to the point that it engulfs your gains. And that’s exactly what can happen if you allow market losses to deepen and go unchecked. Not addressing your losses by ignoring them or making excuses is like refusing to treat a cut. It can become a hemorrhage—or worse. You’d never allow that situation to occur health-wise, so why would you risk it happening in a monetary sense? But it does occur time and time again. Let me say it here and now in no uncertain terms: if you’re not willing to take losses and admit mistakes, then the business of investing or trading in the stock market isn’t for you.

  How you deal with your market losses is a defining characteristic in attempting to achieve investment success. Make no mistake about it: you will be faced with stressful, money-losing situations on many occasions in your investing career, just as life often throws you a curve ball. It happens. Things don’t always flow smoothly in either sphere. You need to have a plan to deal with these occurrences. If I’m holding a stock position at a loss, here’s what I do:

  1. Halt further purchases. I usually have a set price range in which I’ll accumulate shares. But once that range is violated I take a step back and, in keeping with our relationship theme, assess the situation. I check to see if there’s been any significant damage to the stock’s chart pattern. If it’s basically intact I’ll retain the position, but wait until the shares start to perform better on a supply-demand basis before resuming my purchases. However, if I see some technically troubling signs from analyzing my price graphs, my share sales will be in proportion to the extent of the damage I determine. For instance, I’d be a more aggressive seller of shares if my technical research revealed longer-term deterioration as opposed to a shorter-term supply-demand difficulty. On the buy side, I rarely purchase my full equity position at once, preferring instead to do so on several occasions over a period of time based on risk/reward considerations.

  2. Question my thinking, not the market’s. When a position goes against me, I don’t blame the market. I don’t assume that it’s wrong. It’s my error, my fault, my “bad.” As I’ve said before, the stock market is both judge and jury, and its verdict—the price quote—is final. All the excuses and reasoning in the world won’t change that. The stock market is the beach; I’m only a grain of sand on it, if that. I accept its verdict and proceed from there. Reality, in stock market terms, is the price of your shares. Period.

  3. Don’t penalize the winners. I know there’s a temptation to consider selling one or more stock market winners to pay for a losing name. I’ve been in that situation myself. The desire to take a gain will outweigh the desire to take a loss in the majority of cases. After all, taking credit for a market winner is far easier than accepting blame for a losing trade. It’s like that in life: discussing our successes is enjoyable; far less so our failures. But that’s not a sensible investment game plan. Why penalize a name for acting better than the shares in which you’re experiencing a loss? It’s like deciding to break up with someone who enhances your life’s “portfolio” in order to date someone with whom you have little in common or don’t get along with. It doesn’t make sense. In the stock market as in life, you’re better off removing yourself from a negative force than removing yourself from a situation that’s going satisfactorily.

  4. Dwell on it. You might argue that dwelling on your losing trades is like regularly remembering your car accident, a bad real estate deal, or that difficult breakup with your boyfriend or girlfriend you experienced years ago. Why do that? Because you want to learn from the experience and try not to repeat the error. You want to examine where you think you went wrong. Hey, it’s a piece of cake to remember your market winners and the good times, but do we really learn from them? Isn’t an ongoing purpose of life to note our errors and correct them in order to become better individuals? Learning from your market miscues can aid you in becoming
a better investor as well. Face them.

  5. Look at a worst-case scenario. I don’t mean to sound depressing. Actually, yes, I do in this particular case. While worst-case scenarios usually don’t materialize, you need to plan for them since there’s no way of knowing which situations can turn out that way. Isn’t that why we have insurance, extended warranties, generators, home alarms, and the like—just in case? Doing so also makes for a humbling demeanor, investment-wise. It keeps you in market reality. In chapter 7, “Financial Freud,” one of the questions I suggest you ask yourself is, “Do I have more than enough money in reserve in case something totally unexpected occurs?” Make sure that a sudden slide in one or more of your holdings or the market in general won’t take you back a giant financial step, and review your overall financial situation to see if you’re overextended in your investments relative to your monetary responsibilities outside of the stock market. Remember, unexpected things happen. Don’t think that they won’t. And don’t ever be complacent.

  A well-thought-out risk management plan is a crucial element of any investment strategy. Losses are a part of that plan. Taking a loss is an art; how you fare in that area is perhaps the most important determinant of your long-term investment success. After all, you can’t invest capital in a bull market if you haven’t properly preserved it during the prior bear market phase. Depending on their investment styles and strategies, stock market participants will have varying risk tolerances before they admit defeat (accept a loss). Shorter-term traders are going to have different parameters for buying and selling stocks than long-term investors will. No matter which approach you choose, and there are several, the key is to be able to manage the downside portion of the investment equation. While I’m not a short-term trader, if a position I’ve purchased suddenly goes against me and violates what I believe to be price levels of import, I’ll sell the shares. No excuses.

  In the stock market, as in life, concentrating on your mistakes and faults isn’t appealing, but it’s mandatory if you are going to have a shot at correcting them. Just as one needs to be alert to see flaws in an individual that could hurt a relationship and gauge if its seriousness dictates an end to that bond, investment vigilance and regular review is warranted in deciding when to part with all or part of an equity position.

  The approach I preached to the brokers at the large wire houses in which I was privileged to serve grew out of my own personal trading experiences and market observations. I called it TARMA—the Technical Analysis Risk Management Approach to investing—its cornerstone being that capital preservation should always precede capital appreciation. I never give a speech without referring to it in some fashion.

  Risk must be managed in both life and the stock market. Maybe that’s why, with regard to the former, I’ve only owned Volvo automobiles—because I see the road as one big danger zone. Contrary to what you hear about a car being a bad investment because it loses value so rapidly upon leaving the dealer’s lot, I view the scenario much differently. A car with a top-notch crash test and advanced safety features ranks as a great investment in my book, especially for the kids! It’s far more important than capital preservation; it’s potentially life preserving. You’re in your car a lot, which means that you’re exposed to risk often, which means that you have to address that potential risk by owning a safe vehicle. I also have air purifiers in my house (eight, plus two commercial-grade ones for construction projects), earthquake insurance (yes, in New Jersey), and regularly trim the tree branches near my home. I’m always assessing risk. While you may think I’m going overboard in this area, I believe it has helped me, as well as those I have served, over my stock market career. All right, so it stresses my patient wife at times and rightly so. Still, my investment motto is “more worry rather than less” because I’ve seen the catastrophic financial toll a big bear market can inflict. To me, planning for the unexpected always makes sense.

  Moral: Risk management should occupy a central role in your stock market investments just as it does in your personal life. It involves planning for the unexpected and addressing difficulties head-on. Strongly consider using the investment tenets mentioned in this book as a component for your risk management investment plan. Read the accounts of experienced money managers and traders who have successfully implemented strategies to address market risk and preserve capital during bear markets, as well as the financial consequences experienced by those who didn’t. And don’t forget to read Reminiscences of a Stock Operator, a timeless stock market classic written in 1923.

  Chapter 6

  Language Barrier

  Studying the stock market is like learning a foreign language. You must start from scratch. I want those words to act as an indelible neon light that flashes continuously in your mind throughout this book. So before going any further, close your eyes and clear your mind of all previously held thoughts, views, notions, and beliefs you’ve had about investing in the stock market. All of them. Forget what you have been told up until now. Banish it all from your memory! For the remainder of this book I’d like you to think about the stock market differently than you probably ever have before—in the market’s terms, not your own.

  That’s because the stock market has its own set of rules. They fly in the face of what you have probably been told, read about, taught, or led to believe previously about investing. They are often the opposite of what you think makes perfectly good investment sense. It takes the ultimate in financial flexibility to make them a part of your investment philosophy as you navigate the market’s choppy waters, but once you do this you’ll never view the stock market in the same way again. You’ll respond to changes in the investment landscape differently than before. You’ll let the action of the stock market, and not the views of the “experts,” news from the company, or economic releases be your most trusted analytical guide.

  To reiterate, this won’t be easy at first. It will involve breaking old habits—responses to stock market behavior that may be ingrained from investment birth and that the majority of market participants, even experts, still believe wrongly to this very day. After all, we’ve all been raised with a set of rules that govern how we think and act and relate in our everyday lives. They form the basis for our long-held views and beliefs on a wide range of topics. But stock market–wise, you must succeed in clearing your mind of them if you are going to get the most from reading this book.

  Isn’t it fascinating that one of the keys to improved stock market success—breaking old habits—is not a financial trait, but rather a personal one? All the financial training in the world cannot properly prepare you to adjust your thought process to that of the market’s. This trait cannot be bought; it is earned through your capacity to get your thinking in gear with the market’s movements. As with relationships, the best pairings are when you’re both on the same page and “get” (as my wife likes to say) one another.

  This is a key chapter in this book because it involves moving beyond the monetary realm to the psychological one (more on this later). Take a moment now to think about what I’ve just said and let it soak in, realizing that psychological and monetary considerations go hand in hand when it comes to investing. They’re also important factors to balance in relationships. The psychological side of investing has received little attention and needs to occupy a larger role in the investment arena.

  It has been said that we all have the capacity to change. This should apply to your financial as well as your individual behavior. All I’m asking (okay, pleading) you to do is consider altering your investment thinking to get more in line with the market’s. Now clear your mind, commit to becoming financially flexible, and start focusing on the ins and outs of learning the market’s language.

  Moral: The key to unlocking some of investing’s most profitable doors lies in learning the stock market’s language by studying its movements—from scratch. Aligning your thinking with the market’s is a key investment pillar, and just as in a personal relationship, being on the same
wavelength can improve your odds of success.

  Chapter 7

  Financial Freud

  The stock market specializes in inflicting emotional turmoil. It tests your ability to withstand financial pain, trying to shake you out of a bull market well in advance of its eventual peak and rallying just enough in a bear market to convince you that the worst has passed (and to retain your positions) before plunging further. And with increased volatility compressing moves that used to take years into months, and moves that used to take months into weeks, it’s no wonder that investors’ emotions are becoming more easily frayed in the global, nonstop trading environment we’re experiencing.

  Preparing for financial battle involves not just having capital to invest, an investment discipline to help guide you, and a risk management view on your holdings, but also knowing how you’ll react to potentially sudden, sometimes violent market swings that can last for weeks on end with your hard-earned capital on the line. Your answers to the following questions will help define your emotional investment profile:

  1. What are the limits of your tolerance for financial risk and monetary pain? Do you set boundaries?

  2. Do you have more than enough money in reserve in case something totally unexpected occurs? Are you a sound financial planner?

  3. Are you able to effectively process the information necessary to make a sensible investment decision in tumultuous times, or do you tend to remain passive and not face the situation?