Small Profits Often – Bread and Butter Short Term Investments
A journalist once asked J.D. Rockefeller, “Gee Mr. Rockefeller, how did you get so rich?”
Mr. Rockefeller answered coolly, “I guess I took my profits too soon.”
From this short exchange it is notable that successful investors are humble and insightful. More than merely rely on a list of stocks, they accept that they are vulnerable to a collective market that is far larger than their breath of understanding or ability.
Small gains obtained regularly are a legitimate investment technique. Contrary to the ego centricity and glamour of the bombastic investment set, many investors have generated a fine income simply from subduing their egos.
In floor trading of anything from equities to 30 year mortgage rates, , such investors would provide liquidity by sitting on the purchase price and the sale price, hoping only to make the difference. If there is a risk of losing money they quickly cover the investment at cost. When done in large volumes in a liquid market, investors of this mentality have minimum risk exposure, yet enjoy consistent profits. Their estranged counterparts seek to make profits from predicting longer runs in the market, and subsequently engage losses of equal magnitude. It is the diligent and industrious investor that places risk in its proper perspective and brings home the bacon.
Another technique that escapes the psyche of many investors is emotion management in between short term investment entry and exit.
After entering any trade, an investor needs to be prepared for the prospect that they may well incur a short term loss. Rarely do investors predict the absolute top or bottom of the market and to expect otherwise not only naïve, but arrogant. Investors who have executed a reasoned investment plan will be comfortable in their decision making.
Stop loss orders ought to be part of the decision making process prior to execution of the initial investment. If indeed the market performs adversely, at some point the investor needs to accept that they were wrong. Care must be taken to ensure this level isn’t too close to the entry point or every investment will be stopped out at a loss, and this will only be due to a character that is all too precious for investment. When the stop loss point is determined reasonably, the order to stop loss is placed at the same time as the entry investment, and therefore the investor has the security of knowing the worst case scenario.
On the other hand, a thought may be had for Mr. Rockefeller as the investor ponders what they might do should they indeed accumulate a capital gain on their investment. At this point human beings reveal their true character, even if they are managing investments for top mutual funds. Some become haughty and conceited, over flowing with pride and self confidence. Others become quite nervous, while yet others simply cannot cope with the responsibility and risk losing their hard earned gains.
Rockefeller’s technique of taking profit is sound, yet what he sought to assert is that he didn’t allow greed to risk a profit once he had made it. Of course this depends on how frequently the investor can turn a profitable investment. If this is possible 50% of the time, the profits needs to be taken at a greater distance from the entry point than that of the stop loss, or statistically, the investor will consistently return a loss.
It is here that the short term investment mentality comes to life. The age old adage competing with Rockefeller is to ‘cut your losses, and let your profits run.’ Yet many investments have seen the light of capital again only to plunge once more into the murky depths of loss due to inaction by the investor. For this reason, the investor not only needs to have rationale for the entry point of an investment and the stop loss prior to execution, but they also need an objective for the investment to reach and set a stop profit as well.