The One Investing Tactic You Should NEVER Use

Keith Fitz-Gerald Oct 08, 2014
27 

My mission and vision with Total Wealth is to help you uncover tremendous wealth-building opportunities through our six unstoppable trends, maximize your profits with the best trading tactics, and (perhaps most importantly) protect what you have.

Today I want to keep that promise by talking about tactics.

Many investors think they have this covered but, in reality, the savviest investors are always on the hunt to learn new tactics in the pursuit of profits. Like a chef who discovers new ingredients, they are constantly improving the “recipes” they use for success.

Before we start, though, I need you to make me a promise: that you will NEVER use this one trading tactic we’re going to talk about today.

Ironically, this is one tactic that comes naturally to all of us and a mainstay investment principle used by 99% of the population.

But it undercuts everything else you do as an investor.

Here’s the one tactic you can’t use…

I’ll be right up front. What I’m about to say may make you uncomfortable. Believe me, I get it. I’m hesitant to bring this up because it could easily be taken out of context.

But I will anyway for one simple reason – because if you understand the implications of what Wall Street doesn’t say about this tactic, then you can better interpret what it does say and, more importantly, use that information to create bigger profits. And you will never hear this from Wall Street or your broker… because it’s not in their interest to share it with you.

Brain-Damaged Investors Make Better Decisions

Back in 2006 I came across a study in Psychological Science that was as profound as it was politically incorrect, at least on the surface, anyway.

The implications are pretty striking so you’d think Wall Street would be all over it but, sadly, they’re not. (Given that they’re out for their own interests, that’s no real surprise.) I’ve only seen it mentioned once in the years since, by Ric Edelman, CEO of Edelman Financial.

Here’s what it says.

Researchers at three major universities – Stanford, Carnegie Mellon and the University of Iowa – published findings showing that brain-damaged individuals made better investment decisions than the rest of us.

To be precise, what they studied was the impact of injuries that prevented the brains of the injured from processing emotional stimuli and, by implication, responses to those specific inputs.

Researchers found that when they compared the findings to folks with no brain damage, the “injured” individuals made significantly better investment decisions.

That’s because the human brain is wired to evaluate economic and investing information using connections and pathways that are closely linked to emotional inputs. You’d think this kind of decision making would involve logical brain pathways but that’s not true.

This is why making decisions with your money can be very challenging, especially when the markets are complicated and the investing landscape emotionally charged like it is right now. Because you are taking what should be a logical decision and using emotional receptors to make it.

It’s also why Wall Street wants you to believe money is complicated and why their ads are so slick. Unlike the average individual investor, the Big Boys have spent billions understanding what makes your mind work and how specific inputs prompt specific actions on your part – chief among which is commission-generating buying and selling activity that’s worth $18 billion or more a year to the top 25 firms.

They know that if you’re happy, then you’re generally going to be a buyer, and that if you’re sad or fearful, you’ll be a seller. And usually at precisely the wrong time, I might add.

The result is tremendous underperformance that gets dramatically worse over time.

The latest DALBAR data shows that the average investor earned only 5.02% yearly over 20 years versus the S&P 500 which turned in an average 9.22% annually over the same time frame.

Now you may be tempted to dismiss this result as being abnormal, because of the financial crisis, but it’s not. Investors who fall prey to emotional decision-making fell far behind, even during one of the biggest bull markets in recorded history off the March 2009 lows.

Take a look.


Again, this is an uncomfortable subject for a lot of investors.

Many of my own subscribers thought I’d lost my marbles when I told them in 2007 to batten down the hatches at a time when they wanted to chase performance. On the way down, those who followed along with my recommendations had the opportunity to enjoy returns like the 101.68% and we captured in iShares MSCI Brazil Capped (NYSEArca:EWZ) and 83.33% from iShares China Large-Cap (NYSEArca:FXI) respectively.

The same thing happened in March 2009 when I told them that it was time to buy. On the way up, those same subscribers had the opportunity to capture a slew of double- and triple-digit winners like CNH Industrial NV (NYSE:CNHI), Navios Maritime Holdings Inc. (NYSE:NM), and ABB Ltd. (NYSE:ABB) which we closed out at 104.43%, 104.05%, and 103.12% in three trades, respectively.

So how do you do the same thing?

Three Ways to Remove Emotion from the Equation

Success comes down to removing emotion from the equation… actually, in much the same way injuries removed the emotional processing from individuals in the research I just told you about.

  1. First, use a “risk-parity” portfolio model like the 50-40-10.Wall Street will try to convince you that diversification is the way to go, because not all assets go down at once if things blow up. But there’s a flaw in that model. Spreading your money out to get the lowest mean gains is not a recipe for wealth – in fact, it leaves you at the mercy of unseen risks. Ask anybody who got “halved” twice in the last decade how diversification worked out! Long story short, it didn’t. The best professional investors of our time DO NOT blindly distribute their money across a slew of asset classes, and you should not do it either.

    The better way to go is a “risk-parity” model, like the 50-40-10 portfolio I advocate in the Money Map Report. (I’ll show you exactly how this works soon.) By concentrating assets and periodically rebalancing between core assets, growth/income, and speculative positions, you are effectively “forcing” yourself to buy low and sell high using proven logic – not emotion. Plus, this keeps performance-robbing fees low, which Wall Street hates but you’ll love because it can add a lot to your returns over time.

  1. Second, capitalize on chaos. If you’re like me, you grew up with “buy low, sell high” being pounded into your head. It’s absolutely true – but emotion makes it hard to apply. Knowing that everybody else is panicking should be an open invitation to put new capital to work when prices are low. The key is buying companies that have solid business models and long-term growth potential at a time when they’ve been temporarily put on sale by short-term events.
  1. Third, use simple trailing stops to protect your capital and control risk. The goal here is, again, to remove emotion from the equation. Having a trailing stop percent that’s pre-selected the moment you buy helps you do just that. I typically recommend setting a 25% trailing stop on most investments. As an added benefit, trailing stops help you maintain a calm, reasoned perspective at times when everybody else is seemingly losing their minds (and making tremendously costly decisions that are not in their best interest).

Most online platforms have stops built in. So there’s no excuse for not using them.

To be fair, the common complaint I get on trailing stops is that they force you to sell when you may not want to. I hear ya, which is why I’d like to point out that you can use options or inverse funds to accomplish the same thing.

We’ll go over all these tactics in more detail in the weeks ahead.

For now, just remember, the more “sophisticated” you get, the higher the risk of emotional decision-making. And that’s not the goal.

Simplicity, security, and the tactics needed to harvest big profits – that’s the goal.

Best regards for great investing,

Keith

27 Responses to The One Investing Tactic You Should NEVER Use

  1. Melinda says:

    I have heard if you put your trailing stops into the broker account after buying that wall street or the broker can read those and manipulate that stock so it will fall and sell and then they will come in and buy at a lower prices. Is this true?

    • alan says:

      I think YES, because I have gotten stopped out(a sudden and short duration(minutes)drop in TSLA) before. I am not sure if they can “read” your trailing stops, but imho
      I would say yes, there is always a way if the money is right. If this author(Keith) knows the answer I would appreciate knowing

    • Fabien says:

      It’s absolutely true. When you put a stop price in your broker’s account, it tells the whole market that you’re willing to depart your holding at this particular price. Now, does manipulation happens? It’s possible particularly if the stock price is near the stop price. But in any case, never this information for free to the market. Keep you stops close to the vest. Furthermore, it’s important to know that a stop price is not a price written in stone. A stop price order simply means that when this price is reached your order becomes a market order. With the consequence that your final execution can be much lower that your stop price.

      • Keith says:

        Hello Melinda. Thanks for asking.

        As both Alan and Fabien noted, it’s very real. In fact, there’s even an expression for it: “running the stops.”

        But, there are also ways around this and specific tactics individual investors can use to protect their money and keep from being gamed. We’ll be covering those in upcoming columns so please stay tuned.

        Best regards and thanks for being part of the family,

        Keith 🙂

  2. Brian Connors says:

    It can be true Melinda, great question. The market makers of the stock can see those orders and if it gets close enough they can blip the price right down to take your shares out. It’s happened to me many times. I think Keith would say that the wide 25% stop he recommends reduces this risk, but that this risk is better than the risk of no stop at all if something catastrophic happens. Another thing to consider is that when you place this stop loss order, what happens when the price gets to that trigger level is that your stop loss order turns into a MARKET order. If for example there’s a flash crash again as in 2010, the next price that your new market order might catch can be a whole lot lower than your stop loss order. Your stop loss order will almost never execute at your stop loss price. once it becomes a market order you get the next price that comes down the chute. Aside from using options or inverse ETF’s there are a couple ways to do this better:
    1. Find a broker who has the ability to take a stop loss order that is not immediately placed. The way it works: when the price (either closing price or intra day price, you choose hopefully) hits that pre-determined stop level, ONLY THEN is the order placed into the books as a ‘sell at market’ order. This way the market makers don’t see the order until the (blind) stop is hit.
    2. Check out tradestops.com. You can mirror your accounts there and it will track the stops for you and send an alert when it’s time. If you let it access your accounts automatically this is a pretty good way to go and not allow the market makers to see your intentions/orders. It also allows a bunch of different TYPES of stop orders like intra day, closing, calendar, etc.
    Good luck!
    Brian

    • Keith says:

      Thanks Brian. Both for being part of the family and for providing such a clear answer. You hit the nail on the head and TrailingStops is a great service to help investors mind their P’s and Q’s in pursuit of higher profits if you’d like the extra security in addition to the weekly updates I provide Money Map Report subscribers.

      Best regards,

      Keith

    • Uri says:

      One simple tool I use for most stop orders is the “stop limit” order, where a trigger generates a limit order, thus avoiding heavy downdrafts. I usually set the limit just a tad under the stop value. However, I don’t know whether such a tool is also available for % trailing stops.
      Another tool, available at my broker (Fidelity), is to set a price alert. When an alert is received by me, I can review the situation and decide what to do – including, for example, waiting for a bounce from a deep drop.

  3. Gottfried Bach says:

    Comment on Trailing Stops:
    I am a strong believer in trailing stops, in principle, BUT
    1. Why 25%? Losing 25% on an investment is huge. Why not something like 10-15%?
    Did somebody prove that 25% is the most adequate, appropriate, best, …?
    2. Why 25% on just about every investment recommendation?
    One would think that different types of investments require different %-ages of trailing stops.
    Doesn’t it show some sort of laziness on the recommender’s part to simply always make it 25%?

    Thanks,
    Gottfried

    • Keith says:

      Good afternoon and thanks for asking. I’m thrilled by your question because it shows some really super thinking.

      A 25% trailing stop is a rule of thumb arrived at via thousands of hours of computerized simulation and careful study of market volatility and the maximum adverse excursion of any given stock – MAE for short. But it’s not set in stone.

      Case in point, when the markets really take off on a tear higher, I will frequently advocate tightening them up because volatility has dropped and there are profits to protect. That way, subscribers can collect profits like they did Wednesday when the markets fell in early trading.

      Best regards,

      Keith 🙂

  4. WARREN BEELER says:

    I have been investing for 62 years and when I was learning the ” ropes ” ioof wise investing I lost $ 27,000. on these ” got to have to see this great investment “. They all were losers. Never again will I be ” suckered ” in to any of those schemes. When I am contacted by anyone about a buying opportunity I ask for the TICKER SYMBOL if They cannot provide I say by I am not interested. If they can give me a ticker symbol I do a complete research and can determine whether or not to buy.
    I fully agree never to let your emotions get involved with stock trading.

    • Anna says:

      I’m in the same boat, Warren! I lost 85% of the investment money that it took years to save–all gone in a few hours while I left to do my volunteer work at the local nursing home. I got one of those promising videos in my email and I became just one more ignorant sucker. I did take the time to check out the company’s product, which had great reviews online, but I knew nothing about how to read the “financials”–nor had I ever heard of “pump and dumps.” I’ve been glued to my computer for more than a month now, trying to teach this ‘old dog’ some new tricks before I venture out in deep water again. Still, the subject is so confusing to me. I read everything I can, yet I can’t seem to comprehend it all.

      • Pedro says:

        Anna how i understand what your saying!!I started now in this world and i’m always looking for that peace of information, that person that will tell me the safest way to star, the tricks, the tactics, the meanings of all this.”The easy way is not to invest” said a few “Control the risk” i read, so a took a turn and take a breath,and start my one study, grab the investopedia site and explore it in detail all the information they have, then i mark some site to know througth comments what people are saying about the markets and a few months later i know a little more, but i’m always looking for new way’s to learn to invest, that’s why i land here, because one solid thing is to find a good mentor, second read, read, read and then train those readings, find a platform that give you the oportunity to train with virtual money, it’s virtual so you can apply all the strategies you think are good for you. Invest 10 to 25% of that virtual cash, why? discipline because you can, because discipline is one of the true keys to invest, if you investing 10 to 25% of the money you have to invest it will keep your head above the water to bread and erase one good part of the emotion from your strategy.

        Best regards

  5. Eszter Csutkai says:

    What is a TICKER SYMBOL ?

    • Keith says:

      Hello Eszter and thanks for writing.

      A “ticker” is the abbreviation used to identify a specific company’s stock in publicly traded markets. They can be numbers, letters or both depending on the exchange. For example, AAPL is the “ticker” for Apple. TSLA is the “ticker” for Tesla. It’s a term that descends originally from the symbols printed on ticker tape of a ticker tape machine years go to track trading.

      Best regards,

      Keith 🙂

  6. Mile says:

    I am surprised that the brokers can access our trailing stops and manipulate it. What about iTrade accounts which I am planning to embark.

    Please advise

    Regards

    Mile

    • Mile says:

      I am surprised that the brokers can access our trailing stops and manipulate it. What about iTrade accounts which I am planning to embark.

      Please advise

      Regards

      Mile

  7. Nik says:

    I think trailing stops are robust risk management tools for all markets.

    But perhaps they could be improved a little if we distinguish between bull- and bear- markets and markets which move sideways.

    For bull- and bear- markets I would use trailing stops.

    But for sideway -(or slowly moving) markets I would prefer differences of moving averages (or exponential moving averages) e.g. moving average 10d minus moving average 200d. If this quantity falls below zero, then I would sell in a slowly moving market.

  8. kevin says:

    WOW-I have never even considered the thought of Anyone manipulating stop loss. Learning is as good as profits cause the more one learns the more one profits.Learning comes First. Thanks.

  9. lee says:

    thanks for the 3 points on removing emotion from the equation.

    I’ve read and re-read the article again, and couldn’t find the tactic not to use, could someone point it out to me? (I didn’t think it was the part on the damaged brain investors)

    • Editor says:

      The tactic not to use: Emotion!

      • lee says:

        i was just thinking that a tactic is more of a planned action rather than something innate and a natural response like emotion.

        I don’t think anyone would deliberately use or not use one’s emotions when investing, it’s just inherent in all of us and it may or may not influence or cloud one’s decisions.

        Nevertheless, point(s) taken on what to do and thanks Ed for the clarification.

        • Doug Bedell says:

          Lee, the fact as you say “natural response” is what makes it so dangerous.
          We all have them and when starting to invest they tend to rule. I know
          have done that and lost thousands of dollars.
          Natural response, no thought just emotion, “Help let me out of here” will
          get you hurt many times.
          Doug

  10. Brad says:

    A tactic I’m exploring, instead of the stop, is buying puts as insurance. It eliminates the “gap down” and flash-crash risks, and you have total control over when you get “stopped out,” but it does required more attention in rolling them up or out. And, of course, they aren’t free so they cut into profits when your stocks go only up. I started using them instead of stops as a hedge on stocks on which I was writing covered calls, but I’m not totally sold on the idea yet. But we all agree, owning unprotected stocks is asking for trouble.

  11. mike says:

    I’m glad you made reference to the “risk-parity” portfolio model 50-40-10 in your article and look forward to your elaborations on using this tactic. I’ve read the methodology via the Money Map Report, but often have trouble deciding where to categorize a selection. For example, where would you place GE, to me it is likely a growth pick, but then it’s a stalwart selection at the same time and could be placed in the 50% category, and if you believe in their future strategies then you could put it in with the rockets. Likewise for your True Wealth selections. EKSO and KTOS strike me as obvious rocket selections, but it might take years before they rocket, so should they be placed in the growth category? Or, it’s not hard to envision them as stalwart selections in a world that is rapidly changing it’s global foundations.

    Regards,
    Mike

    • JJ says:

      Mike: I’m a new investor, and would like to know the answer to your question if you ever got an answer from anyone Thank you

  12. EL123 says:

    GREAT IN-SIGHT, THANK YOU.

  13. John R Stockhausen says:

    RE: Keith Fitz-Gerald,
    As always, I really appreciate all of your Emails you send me. They’re all appreciated more than you know.
    Keith, do you know of any (Leveraged ETFs) I could use on the U.S. Markets if they’re (1:1 or 2:1) ratio????
    For the last two days, I got into (SDOW Inverse Leveraged ETF). Fidelity told me this was a (1:1 ratio) & I found out it was a (3X ETF) on the Dow Industrials due to the situation in China’s market. Also, if you have time, could you Please give me (Leveraged ETFs) on Chinas (NYSE Arca YXI Market) ????
    One other thing, You sent me an Email early this month about (30 reasons to stay in the market). Is there a possibility you could Please send me this information on this also????
    All of this really would be appreciated a lot.
    Thanks a Lot, John

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