A successful investment strategy requires a thoughtful plan. Developing a plan is not difficult, but it is often difficult to stick to it in times of uncertainty and events that seem to contradict the plan’s strategy. This tutorial discusses the need to create a trading plan, what investment opportunities best fit your needs, and what challenges you can overcome if you don’t have a plan.
The Benefits of Developing a Trading Plan
You can create optimal conditions for solid investment growth if you stick to your plan, despite opposing opinions of the population, current trends or forecasts from analysts. Develop your investment plan and focus on your long-term goals.
Focus on your plan.
All financial markets can be irregular. It has experienced significant fluctuations in economic activity, inflation and interest rates as well as economic recessions over the past century. The 1990s saw a surge in growth as the bull market drove the Dow Jones Industrial Average (DIJA) up by 300 percent.
This economic growth was accompanied by low interest rates and inflation. During this period, an extraordinary number of Internet-based technology companies were founded as online trading and other computer-dependent businesses became more popular. This growth was rapid, and a downturn was equally rapid. Between 2000 and 2002, the DIJA fell by 38 percent, triggering a massive sell-off of technology stocks that held the indices in a depressed state well into mid-2001. Large-scale corporate scandals contributed to the downturn. In the fall of 2001, the United States then suffered a catastrophic terrorist attack that plunged the nation into high uncertainty and further weakened the strength of the market.
These are the types of events that can weigh on your emotions about your investment strategies. It’s times like these when it’s essential to have a plan and stick to it. At this point you set a long-term focus on your goals. Towards the end of 2002 to 2005, the DJIA rose by 44 percent. Investors who have incorporated their emotions into their trading strategies and sold all their positions have missed this upswing.
The three deadly sins and how to avoid them.
The three emotions that accompany trading are fear, hope and greed. When prices fall, fear forces you to sell low without checking your position. Under these circumstances, you should review the original reasons for your investment and see if they have changed. For example, you can focus on short-term development and sell immediately if the price falls below intrinsic value. In this case, you might miss it when the price recovers.
An investment strategy based on hope could force you to buy certain stocks based on the hope that a company’s future performance will reflect past performance. This happened during the boom of Internet-based dot-com companies in the late 1990s. Here you need to invest your research in the fundamentals of a company and less in past performance in determining the value of your stock. If you are primarily hopeful, you may end up with an overvalued stock with more risk of loss than profit.
The greed can distort your argumentation for certain investments. It can force you to hold a position too long. If your plan is to hold out a little longer to gain a few percentage points, your position could backfire and lead to a loss. In the late 1990s, investors also made double-digit gains on their Internet corporate values. Instead of reducing their investments, many individuals held their positions in the hope that prices would continue to rise. Even as prices began to fall, investors hoped their stocks would recover. Unfortunately, there was never a recovery and investors suffered significant losses.