Quote for the day

"No country, however rich, can afford the waste of its human resources. Demoralization caused by vast unemployment is our greatest extravagance. Morally, it is the greatest menace to our social order." - Franklin D. Roosevelt

Quote for the day

"Your level of success will rarely exceed your level of personal development, because success is something you attract by the person you become." - Hal Elrod

Panic Selling: What causes investors to panic and what you can do about it

“So, what would you have me do?” “Nothing. Sometimes nothing is the hardest thing to do.” If you are reading this, you are most likely a human being. And humans are not programmed like computers. We are emotional beings. This is true whether it has to do with a diet or Panic Selling. Most of our decisions are driven by emotions, not logic.

Imagine you are in your 50s, planning to retire in a couple of years…or you have been investing for over a decade to save for your daughter’s wedding. The Big Day is on the horizon.

You wake up one morning and check your investment portfolio. It is down 10%! One of the stocks in your portfolio has tumbled as much as 35%.

You check business news on your smartphone. The talking heads seem pessimistic. The economic indicators are weak. The government is not doing what it should to revive the economy.

You reach your office and start working. But your mind is stuck on the market volatility. The portfolio is down by only 10% so far. You tell yourself, “It’s OK. The market will bounce back. Everything will be alright soon.”

But part of you is also wondering, “Will the markets decline further?” It could sink 20% or 30% in the next few days or weeks. The pundits are saying the same thing: there is only one way the market can go from here. Down.

Should you sell your stock holdings? If you sell right now, you’ll realize only 10% loss. You’ll still be able to retire in two years…or pay for your daughter’s wedding. What if the portfolio sinks another 20%? That will do some serious damage to your retirement fund or daughter’s wedding fund.

You have been investing so that your money could grow over time and make it easier for you to achieve your financial goals. You never wanted your investments to decline. Losses are not what you expected. This shouldn’t be happening in the first place…especially to your investments.

And now you don’t know if or when the market will rebound. It’s better to sell right now. At least you’ll still have 90% of your money. Your mind wants to preserve what is left.

You know the rule is to “Buy low, sell high.” But now your own money is on the line. It’s more important to preserve the hard-earned money than to follow the rules and risk losing a bigger sum. You want to get out of equity markets with little regard for the price obtained.

This panic selling costs investors big time. When markets fall, the average person starts losing their self-discipline. We are tempted to sell our stocks, ETFs, index funds, and mutual funds to get out of the market.

Most of us are not that stupid…or at least that’s what we want to believe. So, why do we panic and end up doing the dumbest of things? 

There are two main reasons.

1. No Emotional Resilience

Emotion gets people to sell at the bottom…just as it gets them to buy at the top – Howard Marks

If we are in the markets, managing the volatility of our emotions is more important than the volatility of the markets, which you can’t manage.

Our greed and fear make us do irrational things. Behavioral psychologists have found that the pain of losing money is twice as strong as the joy of gaining the same amount.

Nobel Prize-winning psychologist Daniel Kahneman and cognitive psychologist Amos Tversky proposed the Prospect Theory in 1979. They found that gains and losses have a different impact on investors’ behavior. The losses feel twice as painful as the joys of gaining. Investors make their financial decisions based on the impact of gains and losses on their mind.

When the markets go up, our greed doesn’t want us to miss out on the rally. We feel jealous when we hear others’ stories of how they made 30% or 40% gain in just a few weeks. We are tempted to chase high returns. It increases the chances of us investing in wrong assets or at the wrong time.

When the markets are going down, we are panicked and we fear losing more of our money. We take action to protect whatever is left of our investments.

Our brains are not wired to accept losses. So, our natural reaction to losses during a market downturn is flight, not fight. Panic selling is driven by fear, market sentiment, and short-term noise.

“Individuals who cannot master their emotions are ill-suited to profit from the investment process” - Benjamin Graham

Instant access to all the world’s information catalyses our fear and greed. There are thousands of newspapers, hundreds of news channels, and hundreds of apps. All of them are publishing/broadcasting news 24/7. There are analyst reports, brokerage insights, tips from your friends and colleagues, expert commentary on Bloomberg, anonymous tips via messages, and more. Too much noise!

Only a tiny fraction of that information affects our lives. But it does influence our emotions, decisions, and actions. It heightens our reaction mechanisms, causing us to make stupid decisions.

Even when there is a small sell-off, the news media goes into frenzy. When NIFTY index falls 400 points, all the talking heads are like:

NIFTY crashes!

Budget fails to excite the markets

Is this the beginning of the next recession?

Monday’s NIFTY crash wipes out $60 billion of investors’ money!

We see these kinds of headlines everywhere. You’ll never see or hear them say something like:

NIFTY closes Tuesday at the same level it was 9 days ago

That’s not exciting. That won’t scare investors. And that won’t boost consumption of their content. Just turn off CNBC and tune out the noise. That way, you’ll be able to keep calm, maintain your temperament, and make sensible decisions.

Most people who fall victim to panic selling check their statements and the performance of investments too often. The more frequently you check, the more tempted you’ll be to take action – some action, any action.

Of course, you should review your portfolio from time to time, but not more than four times a year. You need to learn how to sit tight in times of volatility.

2. Little Conviction in our Investments

Those of us who don’t have a strong conviction in their investments are highly likely to make irrational decisions in times of uncertainty and volatility. Borrowed conviction never stands the test of time.

Before making an investment, we need to do an extensive research about the business, its financial statements, growth opportunities, risks, management quality, and valuations. We must know why we are investing in a particular security before putting money into it.

If we make an investment based on tips from our colleagues, friends, or Twitter, the market volatility will shake our confidence. Unless you are extremely lucky, you’ll end up selling the investment at a loss.

Carefully evaluate the business. Never compromise on three things – quality of business, quality and trustworthiness of the management, and valuations.
How to minimize the chances of panic selling

We are likely to sell in panic when the markets are falling. The best time to minimize panic selling in the future is right when you START investing.

What you do at the beginning will have a huge impact over the long-term. So, do these things to minimize the chances of panic selling in the future.

1. Understand the Equity Markets

There is no such thing as a market…only a bunch of people who trade – Howard MarksMost of us don’t have a good understanding of the equity markets. We read a few blog posts, watch a few videos, and read some tweets about long-term investing. And then we think we are smart enough to invest in equity markets and reap all the rewards!

Soon we start picturing ourselves as a billionaire. Some of us have even calculated how much money they should invest every month and what kind of returns they must earn to get richer than Warren Buffett. This is going to be so exciting! Until you lose some money.

Stocks are merely paper assets. Their value is in the minds of market participants. And there are dozens of different types of participants…each with their own set of objectives and time horizons.

Speculators care only about short-term price movements. Some are there mainly for the dividends. While some hold on to their favorite stocks for decades. Some are nearing retirement and rebalancing their portfolio accordingly. And some are forced to sell to cover loans. Some focus only on shorting stocks. Some are passive investors. And some geniuses have figured out a secret strategy to make 10x return in twenty-three minutes!

The actions of all these participants will affect our portfolio. What they do with a particular stock is driven by three things – their own plans, fundamentals of a business, and external factors such as economic slowdown, wars, trade tensions, etc.

Remember that there will always be the possibility of wars. There will always be companies missing earnings estimates. And there will always be experts predicting market collapse. There will always be companies going bankrupt. But equities have gone up in the long term despite all that.

Factors beyond our control are always at play. At some point, they will affect our investments. Remember the 2008 US financial crisis? It was the real estate market that triggered the collapse. But stocks of businesses that had little to do with real estate or financial services were also hammered.

Due to factors beyond our control, equity markets tend to be highly volatile. We can’t separate equities from volatility. There are periods of high returns, low returns, no returns and negative returns. You have to embrace all these phases to get good returns in the long-term.

Most of us make the mistake of looking only at the upside when investing in equities. We pay little attention to volatility and downside. The more optimistic we are in the bull market, the more panicked and disappointed we will be when the bear market rears its ugly head.

Market corrections are part of the process. Over the last 100 years, the US stock market has declined 10% or more every 11 months on average.

Understanding and embracing the market cycles will not only give us peace of mind, but also help us make the right decisions.

In fact, if you are prepared for it, a downturn could be a wonderful opportunity to buy great stocks at attractive prices to boost your long-term returns. The unprepared get panicked, missing the opportunity to benefit from volatility.

2. Build a Financial Foundation

Most of times, people are forced to sell at inopportune moments because they didn’t build a strong foundation before investing in equities.

They don’t have enough money in emergency savings. The money they need for a goal less than 3-5 years away is entirely in equities.

Ideally, you should have enough money in cash and cash equivalents (high-interest savings, liquid funds, etc.) to cover at least six months of your household expenses. The amount you need for a goal less than five years away should be in a bond-heavy fund. Equities are for goals 5-50 years away.

Have a solid foundation before you start putting money into equities. It will help you endure the volatility and crashes without panicking.

3. Build the Right Portfolio based on your Risk Tolerance and Timelines

We want high returns on our investments. And the possibility of high returns is accompanied by greater risk. You have to find the right balance between risk and reward based on your risk tolerance and how far your goal is.

You’ll minimize the chances of panic selling in the long run if you have the process and approach to mitigate risk.

Many of us think we can do it all by ourselves. We think we fully understand our risk tolerance. But here is the truth – most of us don’t! Unless you have lived through at least one major financial crisis (2008 or the 2000 dot-com bust), you don’t understand your own risk tolerance.

Figuring out your risk tolerance the hard way could f*ck you financially. So, do yourself a favour – seek the help of a trustworthy fee-only advisor to construct a portfolio that suits your risk appetite and goals.

The financial advisor will work out an asset allocation plan consisting of stocks, bonds, and other assets based on your unique risk profile and needs. Unless you are an experienced investor, you’ll also need the help of an advisor along the way to rebalance the portfolio from time to time.

When you have a balanced portfolio that suits your risk appetite, a turbulence in the equity markets will not feel as panicky to you as it would to other investors.

Of course, there is the question of risk/return trade-off. A lower risk means you’ll get a relatively lower return.

But remember that the most important thing is to be able to comfortably meet your financial goals. A relatively low-risk, low-return scenario is fine if you are investing enough money month after month to meet your goals.
Conclusion

Stock market drawdowns and crashes can be mentally devastating. Panicking when the markets fall and selling at the bottom is the worst thing we can do to our investments.

Most of us are not Warren Buffett or Charlie Munger. Our emotions will influence our decisions. But if we have built an emergency fund and our portfolio is in sync with our goals and timelines, we are far less likely to panic sell when there is blood in the streets.

Source:  www.valuewalk.com

7 Zen Quotes for the Consistent Trader

Zen Buddhism is not something that can be written down. Zen is not an idea you can grasp by reading a few books, or many books for that matter. The true nature of consistent trading is the same.

Writing and talking about trading cannot fully express what a consistent trader experiences.

Reading and listening to seasoned traders does not guarantee you success in the markets.

This is why trading consistently is so tough. Most people fail despite enjoying success in other fields.

I can’t express the true nature of consistent trading as well. But I’ve read Zen sayings that are strikingly similar to some of my half-formed thoughts on trading. While these sayings are imperfect, they prompt traders to think deeper.

Regardless of your religion or spiritual leanings, as a trader, you will find that Zen-inspired ideas have much to offer. As you will see, the quotes below have little religious references. In fact, many are found in secular writings.

#1: LEARN TO LET GO AND LOSE.

"Learning to let go should be learned before learning to get. Life should be touched, not strangled. You’ve got to relax, let it happen at times, and at others move forward with it." – Ray Bradbury

You need to learn to lose before you win. The market is a flow. It’s a process. It happens, regardless of how you feel and what you want. Let it happen, even when it stops you out.

To trade consistently, you must feel relaxed. With every trade you take and with every tick the market moves, you should be relaxed. If you feel tensed, you cannot get into the zone and appreciate the market price action for what it is. You will tend to force your desire on it.

This is exactly why over-leveraged traders always blow up. When you are risking too much, you are nervous. And nervous traders tend to gamble, not analyze.

This also explains why well-capitalised traders who control their risk are more successful. When losing trades don’t bother you, you are relaxed. Then, your mind is free to focus on trading.

#2: YOU ARE THE ONLY CONSTANT IN TRADING.

Anywhere we go, we will have our self with us; we cannot escape ourselves. – Hanh Nhat Thich

Among new traders, there is a notorious search for the Holy Grail. This search involves rapid and senseless changes in all possible trading parameters.

• Markets
• Time frame
• Strategies
• Instruments
• Time period

You can change your market, trading time frame and strategies a hundred times. What you always bring with you is yourself.

So before you switch yet again from day trading forex to swing trading equities, look inwards.

Do you need to change?

When you trade:

• Are you following your rules?
• Are you scared?
• Are you greedy?
• Are you trying to prove yourself with some ridiculous profit target?
• Are you over-trading?
• Do you really have a plan?

There are many more questions you can ask yourself.

The point is to find out if the problem lies with you. Do that before looking for external reasons to explain your trading losses.

#3: LEARN TO BE AWARE OF YOUR EMOTIONS AS YOU TRADE.

"Awareness is the greatest agent for change." – Eckhart Tolle

A key step to becoming a consistent trader is to be aware of what’s wrong. And the hardest thing to stay aware of is your emotions while trading. Only when you are aware, you can stop doing what’s wrong, and start to change.

As you trade, keep asking yourself these questions.

• Am I taking this trade out of fear?
• Am I taking this trade out of greed?
• Am I taking this trade because I am bored?
• Am I taking this trade because I want to feel like I am a trader?

Once you recognise any of these undesirable states of mind, stop trading immediately. If you want to be consistent, never trade out of fear, greed, or boredom.

My worst losing streaks always happen when I lapse into a short-lived mania. My emotions become a blur to myself. And there’s zero self-awareness.

Also, many discretionary traders have a problem. They cannot distinguish between:

• A valid discretionary trade (made with accumulated market intuition); and
• A rogue trade (that breaks trading rules and seeks excuses).

But if you are aware of your emotions while trading, you will be able to tell a valid trade apart from a rogue trade. This is because if you are not scared or greedy or bored, and still feel a push to enter the market, that might be your trading instinct speaking.

#4: LOOK INSIDE FOR HELP.

"Work out your own salvation. Do not depend on others." – Buddha

Every consistent trader I know depends chiefly on himself or herself.

They do not worship any trading guru. They do their own research. They do not expect handouts. They do not blame external factors for their failures. At times, they scrape through. But they survive, on their own.

Of course, exchanging trading ideas is great. New ideas can help us improve.

But a consistent trader knows not to depend on the trading book author or the lead trader in the prop firm.

To trade successfully, you can only depend on yourself.

#5: THE BEST TRADERS ARE HUMBLE.

"When an ordinary man attains knowledge, he is a sage; when a sage attains understanding, he is an ordinary man." – Anonymous

With some technical trading knowledge and experience, you become a trader.

But when you become consistent and profitable, you feel ordinary again. This is because you’ve grown aware of the great uncertainty you face in the markets.

You’ve gained a strong appreciation of risk. In fact, your respect for risk is so deep that you would feel humble. And in that sense, you will feel ordinary.

#6: DON’T AIM FOR WONDER TRADES. AIM FOR A STRICT TRADING ROUTINE.

"Zen is not some kind of excitement, but concentration on our usual everyday routine." – Shunryu Suzuki

You might have heard a saying that profitable trading is not exciting; it is boring. That’s true.

You can feel excited about trading, but you should not feel excited about each trade. If you feel excited about each trade you take, you are probably more of a gambler and less of a trader than you think.

The most profitable trading is most unlike gambling.

Gambling depends on luck, a toss, and a roll. It’s exciting because it’s pure chance.

Profitable trading relies on strategy, process, and discipline. It’s boring because you know exactly what you need to do.

In a nutshell, ignore the trades. Focus on the process.

#7: FOCUS ON TRADING SIMPLY

"The more you know, the less you need." ― Yvon Chouinard

The more you learn about trading, the less you need to trade.

All traders go on a same curve. They keeping adding tools and tricks to their trading framework. Most of them never stop adding, and they are the ones that stagnate in their trading career.

A minority will start to downsize their trading toolbox. They will replace their indicators with understanding, and substitute price patterns with experience.

Seasoned technical traders focus on trends and market bias. Exact price patterns become less important to them. They know that once they get the big picture right, they don’t need a candlestick pattern to enter.

This applies regardless of how you trade. The best fundamental traders focus on themes and not news. A few macro themes beat a barrage of CNBC news.

WORK TOWARDS TRADING WITH ZEN

Trade, think, and experience the market. But don’t fixate on these quotes. As a Zen saying goes:

"Don’t confuse the moon with the finger that’s pointing to it."

This list of quotes is just the finger pointing you to things that matter to a trader in the long run.

Source: www.tradingsetupsreview.com

Quote for the day

"A true leader has the confidence to stand alone, the courage to make tough decisions, and the compassion to listen to the needs of others. He does not set out to be a leader, but becomes one by the equality of his actions and the integrity of his intent." - Douglas MacArthur

Quote for the day

"The essence of strategy is that you must set limits on what you're trying to accomplish." - Michael Porter

25 Habits of Highly Successful Investors

By Sam Eder 

Successful people form good habits.

Day in day out their actions are a reflection of effective processes that have been ingrained through hard work, discipline and education.

This is particularly true of professions that require high performance, such as elite athletes, military personal, leaders and investors.

The good news is these habits are nothing mystical. They can be taught and sometimes simply awareness of them can make a vast difference.

Join me on a wander down the path of the habits of investment success and see how you can change for the better.

Habit #1:Successful investors take responsibility.

The cornerstone of a effective approach to investing is responsibility. By taking responsibility for your own profits and losses, you gain control over your financial destiny.

It is easy to look for others to blame, be it your money manager, stockbroker or even the market itself. By accepting it is you who is the ultimate determining factor in your success, you gain the ability to work on yourself and improve the way you invest.

Habit #2: Successful investors have in-depth objectives.

They have clearly defined goals.

You should know the reason why you are investing. Perhaps you are looking for an early retirement on the beach (nice!) or would like to help a loved one live a better life (nicer!). These powerful motivations keep you from straying “off the beaten track” and help you invest with discipline.

Once you have uncovered your greater purpose, you can then define a returns goal/s (i.e. 20% a year) and a risk goal (i.e. I don’t want my account to be down more than 20%). Once you have these objectives, you then can develop a position-sizing model to help you meet them. More on that later.

Habit #3: Successful investors are prepared to take risks

Acceptance of risk is a challenge for many investors. They would (or course!) prefer that they could make money without ever having to lose any.

But losses are a fact of life in the markets. And accepting this is a positive thing. It frees you to create an investment plan that lets you move towards your goals.

I recently saw the power of this concept in action, at a nine-day training course with market wizard and world-renowned trading psychologist Van K. Tharp.

Tharp had recently shifted his tolerance for risk in his company retirement account. Previously his goal had never been to have a losing year. He then established a new rule that allowed him to risk the chance of a 25% drawdown on the account, but only if the investment opportunity was A-grade.

By doing this, he was able to invest heavily in a silver stock that was trading for below the amount of cash it had in the bank, let alone the value of the silver it had in the ground. The stock quickly rose from $3 to $11 while he was heavily invested, giving him the best year he had ever had.

If he had not accepted the risk of a 25% drawdown on his account, he would have never been able to capitalise on the opportunity like he did.

Habit #4: Successful investors have an edge.

An edge is an advantage that over time will provide you with healthy profits from the market. All successful investors have established an edge over the markets.

Examples of edges that successful investors have include:

• Buying undervalued stocks
• Waiting for a certain chart pattern to occur
• Following an investment strategy like William O’Neil’s CANSLIM
• Getting investment advice from someone with an edge.

Habit #5: Successful investors have powerful beliefs.

A. “It’s easy to make money if I am well prepared”
B. “The markets are difficult and risky”

Which of these beliefs does the successful investor have?

It’s obvious that it’s A.

What is not so obvious is that the successful investor would have held that belief before they became successful.

Top investors make a habit of cultivating a powerful belief structure.

And they are prepared to pick and choose the most productive beliefs and wear them, even if they might not necessarily believe them when they first put them on.

By choosing the beliefs that will make you successful, you give yourself a framework that will allow you to prosper and grow. The very act of choosing the belief creates an attraction towards it becoming a reality.

Habit #6: Successful investors achieve their goals through position sizing…not stock picking.

Position sizing is the most important habit a successful investor can have. Bar none.

Position sizing is not “asset allocation” or some other financial mumbo jumbo. It is knowing exactly how much you are risking on each investment so that you can achieve your objectives.

It is based off the historical performance of your investing system for the current market type (see point 6).

For example, if you know that for every 10 stock trades you place in a bull market on average you will have eight winners that will be twice as big as losers, then you can risk more than if you have only four winners out of every 10 trades.

Successful investors know their goals and their expected performance, and decide how much to invest based on this understanding.

Habit #7: Successful investors identify the market type

Would you invest the same way in a bull market as a bear market?

Successful investors don’t. One of their core habits is market type identification.

They know what the current market type is and adjust their strategy appropriately. Furthermore, they are aware that the market type could change at any time and are well prepared for the shift.

Habit #8: Successful investors stalk the market

Successful investors are hunters.

Using a well-cultivated habit of patience, they stalk their investments before placing them.

Once you have an idea for an investment it can be prudent not to enter a trade immediately. It’s best to wait to place trades under ideal conditions. Wait for the right set-up to occur and then zoom in on the price charts to look for an entry with an even better risk to reward (see point 13 for more on risk/reward).

Habit #9: Successful investors have simple entries

Take a successful investor and an amateur investor.

One is complex.

The other is simple.

But perhaps not in the way you might think.

The successful investor has the habit of simplification, particularly around when to buy. They know that the entry is not as important to their results as how much they trade or how they manage the trade once they have entered (exits).

Amateur investors tend to overcomplicate and overvalue the buy signal, when their real focus should be elsewhere.

Habit #10: Successful investors have complex exits

While they value simplicity, successful investors will have many reasons to exit from an investment.

For example, they may have:

• A initial stop-loss
• A profit objective when they enter the trade
• A trailing stop to protect profits while in the trade
• A risk/reward stop to ensure the trade makes sense
• A different trailing stop that comes into play if the market type changes.

These exits all serve to maximise profits and minimise the inevitable losses.

Habit #11: Successful investors let their profits run

An oldie but a goodie. One of the habits of successful investors is to let their profits run.

If you are in a good trade, don’t be tempted to take your profit quickly. Use a method that protects your gains, and at the same time allows you to capture big wins if the trade does go well for you.

Habit #12: Successful investors cut short their losses

The flipside of letting your profits run is cutting short your losses.

Successful investors see losses as a “cost of doing business” and are quick to realise any losses.

Amateurs will do anything to avoid taking a loss, including holding onto a big losing position.

If you do one thing when investing in stock, make sure you have a stop-loss and abide by it.

Habit #13: Successful investors understand risk/reward

A cardinal habit of the successful investor is checking the risk/reward of a trade before entering into a position. If it is not favourable, then they won’t place the trade.

You want to have a risk/reward of at least 2:1 on any individual trade. Your potential profit from the trade should be twice as big as your potential loss. This means that if you only get 50% of your investments correct, you would still come out a winner.

Habit #14: The more they lose the more money they make

I’m going to leave this section to the esteemed Dennis Gartman of the Gartman Letter, who sums this habit up perfectly with this story:

“I'm good at trading and I'm wrong a lot according to my wife. When we got married, we sat down the first year and she said you know this is really very sad. You had a good year at trading. You made us a very nice living this year but Dennis you were wrong 53% of the time this year. I thought this was terribly harsh. You couldn't even beat a coin toss. I got out of it by saying, Sweetheart I'm so in love with you that it’s coloured my ability to think. She bought it. I got another year. We sat down the second year. She said, my wife the accountant, one plus two equals three. She said this is really very sad. You made more money trading this year then you made the previous year. But this year you were wrong 57% of the time. And people pay you for your ideas. And I’m standing by the notion last year that I told you. You can’t even beat a coin toss. You need to do better. Sweetheart I'm trying.  Third year we sat down. My wife, the accountant, one plus two equals three. She said this is sad. You made more money than you made the previous two years. That’s lovely. I want to stay with you. But Dennis, you were wrong 68% of the time this year. Almost 7 out of 10 of your trades lost money. You have got to do better. I told her Laura I'm trying. I'm gonna try. Fourth year we sat down. My wife, the accountant, one plus two equals three. She said, you know, I get it now. You had the best year you ever had. Made more money this year then you made the previous three years. That's lovely. This year you were wrong 81% of the time. I think if you can just be wrong 95% of the time. We're gonna get stinkin' rich. I think I can do it. I think I have it in my grasp to be wrong.”

Habit #15: Successful investors have a mental model of the market

Successful investors develop a story about the market and how it works.

They organise their thinking into a detailed set of beliefs about how the market works and have a routine in place to monitor its elements.

See this video by Ray Dalio, the world’s top hedge fund manager, who has made his mental model come to life.

Habit #16: Successful investors know that their mental model is often wrong

Successful investors trade what is in front of them.

Most likely, you will have several beliefs about how the market works (your mental model).There will be occasions where those beliefs don’t mesh with reality. Even if your belief is logically correct, the market may do something different.

If you hold too tightly onto that belief, then you may not see the market for what it truly is and miss out on significant opportunities or hold onto a losing position for too long.

Have a “grain of salt” about your mental model as the real world won’t always match up.

Habit #17: Successful investors treat investing as a business

Successful investors manage their investments like they would a business.

They have a carefully constructed business plan for their investing and follow a “rules-based” approach to selecting, entering and exiting positions.

A business plan is a formalisation of many (if not all) the habits in this article. It includes:

• Objectives
• Psychology
• Trading strategies
• Contingency plans.

Developing your plan should be a fun experience – and your plan should be enjoyable to read. You’re not in school or at work so make it lively and motivating!

Habit #18: Successful investors record their investments diligently

If I was to ask you “what percentage of successful investors record their trades?” what would you say?

0%

20%

50%

100%

If you said 100%, you would be the closest to being correct.

If I asked you “what percentage of amateur investors record their trades?” most likely the numbers would be reversed.

Now, what if I ask you “are you recording your trades?”

Successful investors have developed the habit of recording each trade they make. They know that without recording their results, they won’t know what is working and what is not, so they won’t know what to change to improve.

Habit #19: Successful investors review and monitor their investing systems

Successful investors will periodically review their investing strategies, as well as monitor their performance in real time.

If a strategy starts to deteriorate, they know about it and can stop trading or switch to a new strategy.

For example, if you were trading mining stocks and then the fundamental picture changed to be less favourable towards mining stocks, impacting your performance, you would know early on in the piece.

Habit #20: Successful investors do self-work

“An investment in knowledge pays the best interest” – Benjamin Franklin

Successful investors know that they are the most important factor in the profit equation.

Their success or failure is entirely dependent on their own skill and ability to execute, so they spend less time focusing on the market and more time on themselves.

To emulate their success, you want to cultivate a habit of self-improvement that allows you to consistently function at a high level.

Occasionally you will get your butt kicked by the markets. Self-work will give you a foundation of strength to remain persistent even in times of stress.

Habit #21: Successful investors prepare like an elite athlete before an event

Like an elite athlete, successful investors only place trades when they are in an optimal mindset. If their “head space” is askew, then mistakes happen.

Similar to their athletic counterparts, these investors have a routine to ensure that investment decisions are made when they are in the zone.

This could include:

• Visualising and rehearsing prior to the event (trade)
• Meditating to calm the mind and boost creativity
• Regulating their emotions by using a technique such as feelings release
• Verbalising instead of internalising the investment decision to a colleague or loved one.

By freeing yourself of negative emotions such as fear or greed, you put yourself in a state from which you can make unencumbered and clear investment decisions.

Habit #22: Successful investors unify body and mind

There is a deep connection between the performance of the mind and the health of the body.

You may notice that when you feel an emotion you feel it in your body. You feel tense across the chest or nervous in the pit of your stomach.

By helping your body relax, you help the mind to relax too. Successful investors know this and make a conscious effort to maintain their physical health. It’s not at all uncommon for top investors to practice yoga or run marathons.

You don’t need to go to the extreme of running marathons; you could simply do some stretches and breathe before making any investment decisions.

Habit #23: Successful investors know when to stop

As tempting as it may be to stay continuously bonded to the market, successful investors know that sometimes they need to switch off and unplug.

If you:

• Have just suffered a loss that was large or traumatic
• Are feeling burnt out
• Are gambling instead of investing because you need some excitement
• Have loved ones that are not getting the attention they need.

Then it could be time to take a break. And be proactive about it. Plan breaks ahead of time, and plan to spend time with your family regularly. You have other areas of your life that need attention too.

Habit #24: Successful investors practise gratitude

Successful investors practise the formidable habit of gratitude.

If you have the ability to achieve your goals through investing, you are fortunate. It can be wise to be thankful and acknowledge the good things you have in life.

Gratitude is highly recommended for investors. And like the earlier habit of powerful beliefs, it is worth practicing before you achieve the success you are chasing.

Gratitude keeps you happy and helps you stay grounded. Overconfidence and arrogance are the market demons that gratitude keeps in check.

Habit #25: Successful investors understand investing is a game and that they make the rules

As an individual you invest in an unlimited environment.

No one is telling you what to do. No school teacher. No boss. No stock broker.

Successful investors know that they make the rules.

Yes. There is a framework – a matrix – which you operate in, but within that you are free to choose how you play the game of investing. So why not choose rules that advantage you?

Source: www.spoonfedinvestor.com/

Quote for the day

"Small opportunities are often the beginning of great enterprises." - Demosthenes

The Best Way to Handle a Stock Market Panic

By Dan Ferris

It's normal to feel lousy about your stocks.

The share prices fall... You log into your online account... The numbers are all red and much lower than they were several months ago... And you just feel bad. It's normal.

But be careful you don't let your emotions lure you into making a mistake. That's easy to do... There are a lot of voices screaming loudly in your direction. Almost all of them are trying to scare you so you'll become dependent on them for information and guidance.

I've made my living in the publishing business since 1997. You can count on most people in the industry to sell what they think is popular. And good investment ideas are never, ever popular. Think of how unpopular gold was in 1999 or how unpopular stocks were in 2009.

Still, many investors let the media and the market tell them what to do. When the market rises, they believe it's telling them to buy. When it falls, they believe it's telling them to sell. There's a much larger and even less informed group that simply feels good when stock prices rise, so it keeps buying... and vice versa.

This is the worst type of herding behaviour. It is a terrible way to approach investing.

Value investors don't let the market tell them what to do. They take advantage of the market's offers to buy and sell at various prices. So the delight we take in a falling market is a primary distinction between value investors and others.

Remember... value investing isn't about making great macro calls. It's not about calling the next crisis, or predicting interest rate trends or GDP numbers. It's impossible to accurately predict those things. If you believe you know someone who is able to call the market's ups and downs, just wait a little longer... They'll soon be wrong.

Value investing is about doing research, taking your time, picking great companies, buying them at cheap prices, and holding them for as long as the business continues to perform well. The moment you think it's about predicting the future – and that you've got a crystal ball – you've already lost.

So my advice right now is to tune out the hysterics. Don't panic. And, most of all,don't abandon the discipline of buying great businesses when they get cheap.

When you're feeling lousy about your stocks, this is the kind of information you need to remember.

As long as you plan on keeping your money in the market for 10 years or more... and as long as you buy great stocks for great prices... a falling market shouldn't cause you anxiety.

It should cause you delight.

Good investing.
Source: http://stansberryresearch.com/

Quote for the day

"I am always doing that which I cannot do, in order that I may learn how to do it." - Pablo Picasso

What is the Difference Between Gambling and Investing?

By: Thomas Murcko

“It is generally agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of stock exchanges.” - John Maynard Keynes

What is the difference between gambling and investing? In order to differentiate between the two, we should start by defining them. Comparisons are often made between the two activities, but I've never seen the terms explicitly defined. If you're sufficiently motivated, I encourage you to try to define the terms ‘gambling’ and ‘investing’ before you continue reading this essay… you may surprise yourself. (Go ahead, I'll wait here for you.)

What definitions did you come up with? Are investing and gambling mutually exclusive, or is there an area of overlap? And are the boundaries clearly delineated, or is there a gray area in the middle?

Let’s see what the dictionary says. Here’s what the Random House dictionary on my bookshelf says:

Gamble: "To play at any game of chance for stakes. To stake or risk money, or anything of value, on the outcome of something involving chance."

Invest: "To put money to use, by purchase or expenditure, in something offering profitable returns."

Both seem reasonable upon cursory review, but a closer look reveals that they’re not terribly helpful. The definition for gambling could apply just as well to investing, and vice-versa.

The Dictionary.com web site says:

Gamble: "To bet on an uncertain outcome, as of a contest. To take a risk in the hope of gaining an advantage or a benefit."

Invest: "To commit money or capital in order to gain a financial return."

Again, the distinction isn't clear. In investing, are you not betting on an uncertain outcome? 

Are you not taking a risk in the hope of gaining an advantage or benefit? In gambling, are you not committing money?

Are you not doing it in order to gain a financial return?

Beyond the Dictionary

OK, so the dictionary definitions aren't very useful. Perhaps if we examine some of the ways in which gambling and investing are generally perceived to differ, we might be able to build definitions from those characteristics.

Investing is a good thing, gambling is a bad thing.

I think it would be hard to argue with the claim that investing is, on the balance, a good thing. Investing is widely regarded as the engine that drives capitalism. It tends to put money in the hands of those with the most promising and productive uses for it, and drives the economy gradually upward. Investors aren’t merely betting on which companies will succeed, they’re providing the capital those companies need to accomplish their goals. The U.S.’s leadership position in technology is largely due to investments by venture capital firms, angel investors and technophilic individual investors. Similarly, you can change the world in a small way by investing in companies you believe in, such as socially or environmentally conscious firms and mutual funds, or biotech companies that are working on diseases that might affect you or someone close to you.

Gambling, on the other hand, is not so clearly making a positive contribution. Gambling does tend to help local economies, but also usually brings with it well-documented unpleasant side effects. I’ll leave it up to the reader to decide whether gambling is, on the balance, a plus or a minus. Looking to the financial markets, one could make the case that people who gamble in this realm do serve a function, by adding to the market’s depth, liquidity, transparency, and efficiency. But that’s of relatively minor value, and those gamblers probably capture most of that value for themselves. On the other hand, they often increase the volatility of the markets, which is on the balance usually a negative (although it does afford savvy investors opportunities for larger profits). As Warren Buffett has said,

“Wall Street likes to characterize the proliferation of frenzied financial games as a sophisticated, prosocial activity, facilitating the fine-tuning of a complex economy. But the truth is otherwise: Short-term transactions frequently act as an invisible foot, kicking society in the shins.”

The questions of whether gambling is morally wrong and how strictly it should be regulated are important but are well beyond the scope of this essay, and so I’ll mention them only in passing. Governments generally frown on gambling (unless, of course, they’re getting the lion’s share of the profits, such as with state lotteries). Many religions frown on gambling (but they don’t seem to mind church bingo). I have no problem with a person being morally opposed to gambling, as long as that person knows exactly what he/she means by ‘gambling’.

I should hasten to add that not all types of investing are productive. Buying and holding results in a positive contribution to the economy, but buying and selling quickly, the way day traders do, results in no net contribution. For the purposes of the current investigation, we could either reclassify investing-type activities that aren't productive as gambling, or we could consider these to be exceptions to the rule. I lean toward the latter interpretation.

In investing, the odds are in your favor; in gambling, the odds are against you.

Peter Lynch has said that “An investment is simply a gamble in which you've managed to tilt the odds in your favor.”

But that position is too simplistic. There are plenty of investments where the odds are against you: futures, options, and commodities trading (where you get hurt on commissions and the bid/ask spread), frequent stock trading (for the same reason), and selling short (since the market goes up rather than down in the long run), to name just a few examples. Similarly, while for most types of gambling the odds are against you, it is possible for the odds to be in your favor. I spent one summer during college working in Arizona, and I drove up to Nevada most weekends to play blackjack. By counting cards, I was able to obtain a small but predictable advantage over the house, about 1.5% per betting unit on average. (I haven't returned since then, for several reasons: it’s not intellectually challenging; while card counting is not illegal, Vegas casinos can make you leave if they suspect you of doing it; and I've found it easier and more enjoyable to make money in stocks than in blackjack.) Expert poker players can also make money at casinos, because their competition is other players rather than the house, and as long as the house takes its cut it doesn’t care how the rest of the money is redistributed among the players.

There are additional problems with this attempted characterization of gambling as a losing bet and investing as a winning bet. It implies that a given activity switches from gambling to investing (or vice versa) as soon as the odds swing past the break even point. Similarly, if two players are participating in an activity in which one has an advantage over the other, it would mean that one person is gambling and the other is investing. That would imply that institutions which get in on IPOs at the offering price would be investors, and the little folks that those institutions immediately flip the shares to for a profit would be gamblers. Furthermore, while it’s possible to calculate exact odds for some casino games, this is rarely the case on Wall Street. How can you know for sure whether the odds are for or against you if you decide to buy a particular stock today?

What about venture capital investments, you say? Aren't the odds stacked against them? Yes, the majority of venture capital investments result in loss, often a total loss of the amount invested. However, venture funds typically yield higher returns than stocks because a small percentage of the firm’s investments are home runs, more than making up for complete losses on other investments. So while venture capital might seem like gambling in that the odds are against the VC firms on any given bet, on average the expected payoff is positive, so the odds in the long run are actually in their favor.

Gambling can be addictive and destructive, but investing can’t.

Compulsive gambling has been correctly identified as a problem, and organizations like Gamblers Anonymous are helping people cope with the problem. No similar problem is generally thought to exist in investing. There is no Investors Anonymous, and no one talks about compulsive investors. But while there isn’t yet widespread acknowledgement of investing addiction, there will be soon. Marvin Steinberg, executive director of the Connecticut Council on Compulsive Gambling, recently said this about investing addiction:

"We don't know the true extent of the problem because hardly anyone identifies it as a gambling problem — they see it as a ‘financial problem’ or an ‘investing problem.’ "

Many online investors who claim to be buy-and-hold investors check their portfolios on a daily or hourly basis, and jump in and out of stocks more often than they realize. Active trading can be expensive, both in terms of the commissions and bid/ask spreads and in terms of emotional fatigue. Also, some people invest more aggressively than they should, which is virtually identical to gamblers who bet more money than they can afford to lose. This page provides a list of questions to help a person determine if he/she might be a compulsive gambler. Replace the word ‘gambler’ with ‘investor’ for each question and the questionnaire is equally useful, but for a different purpose.

Gambling is entertainment, investing is business.

As Brad Hill has said, “Global financial markets represent the greatest spectator sport humanity has ever devised. It has planetary reach, a multitude of local competitive arenas, volumes of statistics, star players, and — best of all — anyone can move between the domains of observer and participant, fan and player. If you squint just right, the steadfast newscasters of CNBC appear to be play-by-play announcers, calling the game for U.S. fans. And do financial sections of newspapers differ from sports sections in their presentation of story, data, and personality? Not essentially.”

While the ‘gambling as entertainment, investing as business’ dichotomy may have been clear in the past, the line is being blurred. The internet has enabled online brokerages and other financial web sites to revolutionize retail investing, which on the balance is a tremendous benefit to both individual investors and the economy in general. However, the widespread accessibility of cheap online trades has also attracted some people who enjoy betting and view online trading as a new form of entertainment. The major factors accelerating this trend are that gambling is strictly regulated and not ubiquitous, and that the odds are usually better in investing than in gambling.

Chris Anderson, executive director of the Illinois Council on Problem and Compulsive Gambling, has said that compulsive gambling isn't really about making money, it’s about “action”, and the lure of the big win. While I’m not a neuroscientist, I suspect that the chemical changes that occur in the brains of compulsive gamblers and compulsive day traders are similar, since they’re both riding on the same emotional roller coaster of wins and losses. Similarly, while some people who invest in high-tech stocks do it for the potential returns, others do it because of the rush they get from the tremendous volatility. It feels right to classify the latter group as gamblers rather than investors.

I don’t mean to imply that I think it’s acceptable to gamble for entertainment but not to invest for entertainment. I think both are equally acceptable, provided the person enjoys the activity (as opposed to feeling a compulsion to participate) and provided the person uses only money he/she can afford to lose. But I'm probably not the best person to make a judgment on this question, because I've never found either gambling or investing to be entertaining… my goal has always been value creation rather than enjoyment, and I place bets only where the odds are most heavily in my favor, not where I expect to find the most excitement.

Investing is saving for specific goals, such as retirement, while gambling isn’t.

Many people regard investing as a planned strategy of wealth-building for specific future goals. And this is certainly true of some types of investing. But this is largely a by-product of having the odds in one’s favor. If you have the edge (whether in blackjack or in equities), time and the laws of probability are a powerful combination. Gambling would work just as well as investing for financial event planning if gambling games were in your favor.

Investors are risk-averse, while gamblers are risk-seekers.

Risk-taking is intrinsic to both gambling and investing. There are a few investments that don’t entail risk, such as fixed annuities and government bonds held to maturity, but even those have inflation risk. The major difference between the two groups seems to be the participant’s relative willingness to accept risk. Investors tend to avoid risk unless adequately compensated for taking it, but gamblers don’t. To put it another way, investors take only the risks they should take, while gamblers also take some risks they shouldn’t take. Would you rather have $50 or a 50/50 chance at $100? If you take the $50, you’re an investor. If you go for all or nothing, you’re a gambler. Would you rather put your money under your mattress or in an extremely volatile stock that could go bankrupt or could double in value? The question is slightly different, but the answer is equally instructive. If you expect to double your money quickly, whatever you're doing is probably gambling, even if it happens on Wall Street rather than in Las Vegas.

However, this characterization of gamblers as risk-takers applies only to non-professional gamblers, people who visit Atlantic City for a weekend for entertainment purposes. Professional gamblers who have managed to tip the odds in their favor behave more like investors, shying away from risk unless the reward is sufficient to justify taking the chance. In fact, one could make the argument that investors generally take on more risk than professional gamblers, because of the uncertainty inherent in the financial markets. As I mentioned before, it’s difficult for investors to calculate how much of an advantage they have, but the odds of a given gambling strategy can be known either precisely or at least approximately.

Investing is a continuous process; gambling is an immediate event or series of events.

This rule does seem to hold in most cases. Investing is a continuous process of deployment of capital in search of continually increasing net worth. As a result, delayed gratification is implied. Gambling is a specific act or series of acts, centered around immediate gratification. In this respect, day trading resembles gambling: the participant gets in, the price moves up or down, and he/she gets out, usually in a matter of minutes. The same could be said of buying with the belief that a stock is about to jump, or buying IPO shares with the intention of flipping them in a few hours or days, or buying options which are close to expiration. On the other hand, buying in the belief that a stock’s price will eventually reflect its value, with the plan of holding as long as it takes for this to happen, is more like investing.

Investing is the ownership of something tangible; gambling isn’t.

The latter half of the statement is certainly true, but the former half is only sometimes true. Some investments involve the ownership of something tangible, but many don’t. For example, derivatives are investments ‘derived’ from other investments. An option is a derivative that gives the owner the right to buy or sell a specific amount of a given security at a specified price during a specified period of time. Options are generally classified as investing rather than gambling, and rightly so, but they do not represent ownership of anything tangible. However, when you realize that an option is essentially a bet that a given security will or won’t be above a certain price on or by a certain date, it starts to feel more like gambling than investing.

An even more strict definition of investing would require that it involves the purchase of an asset which either produces a stream of income or can be made to produce a stream of income. But this definition would eliminate such assets as collectibles, stamps, art, and gold, which have no intrinsic value. I don’t think it makes sense to exclude them simply on this basis. We might choose not to consider them investments because of their poor long-term performance, but we shouldn't choose not to consider them investments simply because they won't ever produce a stream of income.

Investing is based on skill and requires the use of a system based on research, while gambling is based on luck and emotions.

A lot of so-called investors don’t do nearly as much research as they should. Many buy on tips or rumors, or based on some analyst’s price target, without doing their own exhaustive research. It feels right to call such behavior gambling. Similarly, investors who are making decisions based on emotions (especially greed and fear), rather than remaining emotionally detached and sticking with their strategy, are to some extent gambling.

On the other side of the coin, some gamblers do serious research, often paying hundreds of dollars a month for real time data on what the current lines are (for example, on http://www.scoresandodds.com or http://www.vegasinsider.com). Professional sports investors devote 12 hours a day, every day, to handicapping sports. They read dozens of newspapers, subscribe to line services, maintain inside contacts, and have years of experience, usually on both sides of the betting counter. These professionals keep their emotions away from the decision-making process. Once they have a system that works for them, they don't second-guess it, focusing on long-term profits instead of day-to-day performance. Also, they concentrate on the areas in which they achieve maximum results. Many professionals bet only on one sport, which bears more than a superficial resemblance to Warren Buffett’s idea of staying within one’s “circle of competence”.

While investing and gambling probably initially appear to be worlds apart, the above attempts at differentiation revealed that the actual differences are smaller than the perceived differences, and that there is a significant gray area in the middle. Based on the above characterizations, it is clear that the appropriate classification isn’t wholly dependent on the activity, but also on the way in which the activity is conducted. There’s a big difference between buying a stock after thoroughly researching it and buying a stock by hitting it on a dartboard. This is true even if the same stock happens to be chosen. Similarly, there’s a big difference between buying exotic derivatives to hedge against an existing risk or position and buying the same derivatives because you saw a website touting them. As a final example, there’s a big difference between buying a government bond in order to collect the interest it earns and buying the same bond in the belief that interest rates are about to drop and the bond’s value will skyrocket.

One interesting thing to note is the pattern of exceptions to the attempted characterizations. Most of the exceptions were people who were doing investing-related things but weren't behaving like investors, or people who were doing gambling-related things but weren't behaving like gamblers. Of the four groups, recreational investors, professional investors, recreational gamblers, professional gamblers, there are more similarities between the two recreational groups and between the two professional groups than between the two investment groups and between the two gambling groups. Specifically, those who use a rigorous system, do research, tilt the odds in their favor, treat it as a business rather than as entertainment, avoid addiction, and keep their emotions in check tend to behaving like investors, and those who don't tend to be behaving like gamblers. It might not be such a stretch to call professional gamblers ‘investors’ and recreational investors ‘gamblers’.

A Third Option: Speculating

Another possibility is that the two terms ‘gambling’ and ‘investing’ aren’t sufficient to cover the entire range of activities under consideration. A third term, ‘speculating’, is often used to straddle the two, specifically to handle activities that would ordinarily be considered investing but are done in a way that make them feel more like gambling.

In The General Theory of Employment, Interest, and Money, John Maynard Keynes defined speculation as”the activity of forecasting the psychology of the market”, and speculative motive as “the object of securing profit from knowing better than the market with the future will bring.” Many people consider billionaire George Soros to be an investor, but he prefers the term speculator. In fact, he has said that“an investment is a speculation that has gone wrong.” What he means by this is that, among speculators, an ‘investment’ is the name they give to a speculation that didn't work out the way they expected and that left them stuck with a position they hope will improve with time. Soros and other speculators make their predictions partially based on market psychology, and in this respect their behavior fits perfectly with the Keynes’ definition of speculation. But there is much more to speculating than just interpreting market psychology, and this definition isn’t sufficiently distinct from the ones we formulated for gambling and investing in the above section.

According to the dictionary on my bookshelf, speculation is “the engagement in business transactions involving considerable risk for the chance of large gains.” By this definition, the entire distinction rests on the degree of risk and size of potential gains. In support of this definition, bond rating agencies commonly use the term “speculative” to refer to high-risk bonds (those rated below BBB by S&P or Baa by Moody’s).

In their book Investments, Zvi Bodie, Alex Kane, and Alan Marcus argue that “a gamble is the assumption of risk for no purpose but enjoyment of the risk itself, whereas speculation is undertaken in spite of the risk involved because one perceives a favorable risk-return trade-off.” But this is too simplistic… no one would play casino games if the only possible outcomes were either breaking even or losing; the rush they experience comes from the possibility of winning and not merely from the taking of risk. They continue:“To turn a gamble into a speculative prospect requires an adequate risk premium for compensation to risk-averse investors for the risks that they bear. Hence risk aversion and speculation are not inconsistent.”This part I agree with. In fact, whether they realize it or not, their definition reclassifies gambling as speculation when the odds can be sufficiently tipped in the player’s favor, such as in professional blackjack or poker, which fits in nicely with argument made in the previous section.

Zvi Bodie et al appear to be saying that in order to be speculating rather than gambling, the person must not take greater risks than are justified by the potential reward. Others say that in order to be speculating rather than investing the person must be taking greater risks than are justified by the potential reward. For example, in Benjamin Graham and David Dodd’s classic Security Analysis, they argue that “an investment operation is one which upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” Both positions are defensible. But perhaps a better interpretation would rest on the realization that different investors have different tolerances for risk. Perhaps speculators are those who are risk-neutral, while gamblers are risk-seekers and investors are risk-averse. While adding the term ‘speculation’ to the mix might have some value, it probably adds more confusion than clarification, so I prefer to leave it out and focus on just ‘gambling’ and ‘investing’.

Conclusions

So what’s my resolution to this definition conundrum? Well, the purpose of words is to communicate concepts. So it doesn't really matter what definitions you use, as long as you and the person(s) you're communicating with are clear about what is meant by those words. And even more importantly, as long as you know what you’re doing, investing or gambling, before you do it.

But with that said, it would be beneficial if everyone could agree on what the terms mean, so we don't need to make our definitions explicit every time we want to use them. To this end, I offer the following definitions, which are built from the various characterizations in the above section:

Investing:

“Any activity in which money is put at risk for the purpose of making a profit, and which is characterized by some or most of the following (in approximately descending order of importance): sufficient research has been conducted; the odds are favorable; the behavior is risk-averse; a systematic approach is being taken; emotions such as greed and fear play no role; the activity is ongoing and done as part of a long-term plan; the activity is not motivated solely by entertainment or compulsion; ownership of something tangible is involved; a net positive economic effect results.”

Gambling:

“Any activity in which money is put at risk for the purpose of making a profit, and which is characterized by some or most of the following (in approximately descending order of importance): little or no research has been conducted; the odds are unfavorable; the behavior is risk-seeking; an unsystematic approach is being taken; emotions such as greed and fear play a role; the activity is a discrete event or series of discrete events not done as part of a long-term plan; the activity is significantly motivated by entertainment or compulsion; ownership of something tangible is not involved; no net economic effect results.”

Speculating – I would prefer to avoid this term entirely, but if necessary I would define it as: “Investing or gambling characterized by a high degree of risk and a high potential for reward.”
Are you disappointed that I didn’t crystallize the essence of gambling and investing into a single distinguishing feature? Did I merely sidestep the ambiguity, and sweep the gray areas and the important exceptions under the rug? I don’t think so. The taxonomy doesn’t have to be completely distinct in order to be useful, nor does it need to be just a single feature. And just because some of the characterizations had exceptions doesn't mean they should be thrown out entirely. Nearly everyone agrees that the concept of ‘chair’ is a useful one, even though it’s difficult to define exactly what the necessary and sufficient characteristics of a chair are.

Why Does it Matter?

Lawmakers and regulatory bodies need to be clear on what the terms mean, so they understand the scope of their legislation and regulation, regarding prohibited behavior, adequate disclosure, participant protection and similar issues. In general, I'm in favor of less regulation and more disclosure for both activities described as gambling and those described as investing, but I'm no expert on the subject and a thorough discussion is beyond the scope of this essay.

Everyone needs to realize how easy the internet makes it to gamble under the guise of investing. When people use generic terms without ever specifying what they mean, it’s easy for those terms to gradually change in meaning, and I think that’s exactly what the internet is causing to happen. I don't mean to imply that the internet’s democratization of investing is a bad thing. In fact, I think it’s the one of the most important developments in the history of investing. My hope in pointing this out is to awaken those individuals who are acting like gamblers but who think they're acting like investors.

Investing addiction is as serious as gambling addiction, and should be treated as such. If more people start to view buying and selling stocks online as a way to get the betting rush that previously required a trip to a casino, is there any reason to think the same negative consequences that follow gambling won’t also follow investing? Perhaps investing addiction is not getting the attention it deserves because most people are attaching to it all the positive connotations of investing and none of the negative connotations of gambling.

Those who have ethical problems or religious issues with gambling (or even investing) owe it to themselves to figure out exactly what they object to and why. As I mentioned, I have no such ethical problems with either gambling or investing, but again, this discussion is beyond the scope of this essay.

I'll leave it to Benjamin Graham to further emphasize why such clarity is essential. In The Intelligent Investor he said: “The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all dealings with the public. Otherwise the stock exchanges may some day be blamed for heavy speculative losses, which those who suffered them had not been properly warned against.”

He continues: “Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook . . . There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are: (1) speculating when you think you are investing; (2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and (3) risking more money in speculation than you can afford to lose.”

I agree completely, and I suspect that his use of the term ‘speculating’ is very similar to this essay’s use of the term ‘gambling’.

Special Disclaimer

* This essay is not meant to condone gambling, or to suggest that you cash out your portfolio and become a professional blackjack or poker player. Those are tough ways to make money, and were mentioned primarily for illustrative purposes.

* We recommend that you get assistance from a professional before doing anything you don’t know how to do.

* Some of these activities, especially those considered gambling, might not be legal in certain places. Even if you find bets for which the odds are in your favor, we encourage you to make sure your chosen activity is legal before participating.
Source: http://www.investorguide.com/