Nobody can predict the movement of the stock market with any certainty. Moreover, emotions often come into play which can significantly affect the rational judgement of investors. When the market is good, most investors are caught up in the euphoria and think that the market will go higher. Their recent past actions to sell turn out to be wrong and the market continues to go higher after they have sold their shares. Slowly, they begin to hold on to their shares longer and might buy even more when the market dips. Eventually, the market runs out of steam and turns into a bear market, generating paper losses for investors who bought when the market was peaking. At the other extreme, when the market is bad, most investors would become disillusioned and unload their shares at a loss. These 2 examples illustrate why the power of emotions in affecting investing outcomes should not be underestimated. If they could be controlled in some ways, it will go a long way towards being successful in investing.
One way to control emotions is to have a plan. This plan is created away from the influence of the market and dictates what investors should do in different market conditions. By following this plan strictly, one can remove the influence of emotions and make more rational decisions in the thick of market action. Without this plan, it is akin to sailing in the seas without a map.
It is easy to create a plan. One of my first basic plan was to tie the level of stock allocation to the stock market index inversely. When the index is high, the level of stock allocation would be lower. Conversely, when the index is low, the level of stock allocation would be higher. By following this plan strictly, it forces me to buy shares when the index is low and sell shares when the index is high. Of course, following this plan almost always results in the stock market going lower when I'm buying shares and going higher when I'm selling shares. However, through this plan, I'm able to make the correct decisions of buying low and selling high without the influence of emotions. Moreover, it is difficult to predict when is the market peak and trough. What this plan advises is to buy when the market is low enough and sell when the market is high enough.
The plan that you create for yourself must suit your own investment objectives and risk preferences. It is not good enough to adopt a plan that works for others. As this plan is needed to guide you through all market conditions, you must be comfortable with what the plan recommends. Otherwise, you would not be following the plan and it would defeat the purpose of creating the plan. Consider all possible market conditions and review if the recommendations are appropriate based on your investment objectives and risk preferences. If they are not suitable, make adjustments until you are comfortable with them. Once the plan is created, you may review and adjust periodically, but not when the market is going through a prolonged bull or bear market which might cloud your rational thinking. After all, the purpose of the plan is to guide you through such extreme market conditions.
Having created a plan that is suitable for you under all market conditions, it is alright if you wish to deviate from it slightly, based on your assessment of the prevailing market conditions. After all, the plan is rigid and does not take into account other factors that might influence the direction of the market. This is known as a tactical allocation while the plan that you created sets the strategic allocation. So long as you do not deviate far away from the plan, the impact of such deviation should be minimal.
As a piece of caution, by following this plan strictly, it takes the fun out of investing. So, now you know why trading shares might be exciting, but it's usually the boring stuffs that make money?
See related blog posts:
See related blog posts: