Investing is a process of self-discovery. Investors rarely find their strategy on the first try. It takes a few attempts.
The reason is simple. First, new investors aren’t handed a menu of investment strategies to pick from when they start. Second, no strategy comes complete with a full list of behavioral requirements that make it a good fit. It’s trial and error, for the most part.
And even when investors find a strategy that fits them, they’re bound to be tested at times that causes them to question their decision. Paul Tudor Jones highlighted two tests every trader will face at least once in their life:
There are two unpleasant experiences that every trader will face in his lifetime at least once and most likely multiple times. First, there will come a day after a devastatingly brutal and agonizing stretch of losing trades that you’ll wonder if you will ever make a winning trade again. And second, there will come a point when you begin to ask yourself why it is you make money and if this is truly sustainable. That first experience tests an individual’s grit; does he have the stamina, courage, guts, and smarts to get up and engage the battle again? That second moment of enlightenment is the one that is actually scarier because it acknowledges a certain lack of control over anything. I think I was almost 38 years old when one day, in a moment of frightening enlightenment, I knew that I really did not know exactly how and why I had made all the money that I had over the prior 17 years. This threw my confidence for a jolt. It sent me down a path of self-discovery that today is still a work in progress.
I can say, investors will face the same experience too. Jones didn’t have any further suggestions on how to handle those two issues, so here are a few suggestions to consider.
1. Start early. Investing early in life has advantages that go beyond compounding. It gives you more time to make mistakes, to learn, to gain experience, and eventually find the strategy that works best for you. Once found, you have more time to tweak and improve it over time.
2. Keep a journal. The best way to avoid repeating the same mistakes is to keep track of your experiences and review it. This is especially true because investing isn’t like baseball, where you can easily play over a hundred games every year. It doesn’t allow you to analyze dozens of games to quickly learn what you’re good at, where you need improvement, so you can apply it, and repeat the process.
Investing is more like a single nine-inning baseball game that’s stretched out over five to seven years (roughly the length of the average market cycle). You can’t really learn much from one game, much less remember a mistake you made at the start of it.
So keeping a journal, writing down your mistakes, tracking your strategy, and your experiences — especially any emotions or reactions during specific market events — should be a helpful reference when making decisions in the future.
3. Expect randomness. Jones refers to the lack of control over investment outcomes. Unfortunately, a strategy can lead you to the perfect investment, you can make the correct decision to buy it, and you can still lose money. Alternatively, you can make the wrong decision and still come out on top. In other words, the market is full of surprises.
Uncertainty, randomness, and luck play a bigger role than we’d like to admit. Yet, it’s our tendency to chalk it up to skill when things work in our favor and bad luck when it doesn’t. The mistake is confusing good luck with skill or bad luck with a broken strategy.
4. Focus on the process. Thanks to randomness, the only thing we do control is the process. So it helps to remember that strategies are meant to tilt the odds in your favor, not produce perfect results.
If your strategy is sound, backed by past data, and you avoid behavioral mistakes, it may still underperform in the short term but over time it should work as expected. And if you understand the role randomness and luck play in outcomes, you shouldn’t be too discouraged when your strategy goes through one of these periods of underperformance.
5. Stay confident. Jones throws out terms like grit, stamina, courage, and guts. Investing is a test of mental fortitude. The ability to stay consistent when the market is delivering pain is what leads to success in investing.
How do you stay consistent? Being mentally tough helps a lot. Having confidence in your strategy is key too. Maybe faith is a better term to use. The point is, a little confidence goes a long way in not giving in to doubt.
- Can Warren Buffett Forecast the Stock Market? – J. Rekenthaler
- Common Probability Errors to Avoid – Farnam Street
- A Reminder: My 10 Rules of Forecasting – Klement on Investing
- Everybody Lies: Pollster Edition – A Wealth of Common Sense
- The Relationship between Sports Betting and Investing – L. Swedroe
- Are Value Investors Just Missing Growth Stocks? – Behavioral Value Investor
- Michael Mauboussin On Valuing Intangible Assets (podcast) – Odd Lots
- A Viral Market Update: A Wrap on the COVID Market, Premature or Not! – Musings on Markets
- Why is Life Expectancy in the US Lower Than in Other Rich Countries? – Our World in Data