“… People will make mistakes. Some will alter their system or jump from system to system as each one has a losing period. Others will be unable to resist second-guessing the trading signals. Whenever I go to a money management conference and sit down with a group to have some drinks at night, I always hear the same story. ‘My system worked great, but I just didn’t take the gold trade, and that would have been my biggest winner.'”
– Larry Hite, hedge fund manager
For many years, I taught a two-hour intensive workshop titled “How to Manage Your Money Like a Hedge Fund.”
No matter how many times I gave my presentation, I found the audience reacted the same way.
I’d share with them my most valuable investing advice and strategies.
These strategies had the potential to both make them millions and save them from potential financial disaster.
Yet I found that my advice fell on deaf ears.
It was only when I illustrated a strategy with a specific stock or exchange-traded fund (ETF) that the audience would perk up, whip out their pens and start scribbling furiously.
I learned that the average attendee wanted only one thing: A hot stock or ETF, one that would go up immediately… and forever.
Now, I bet you’re saying to yourself, “Of course the right stock or ETF is what I’d want! Why else would I be paying my hard-earned dollars to attend an investment seminar?”
But here’s the surprising (and harsh) reality…
Picking the right stock or ETF is only a small part of profitable investing.
I can recommend that you buy the right stock. I can suggest where you should place your stop. And I can implore you to limit the size of your position to match your risk appetite.
But none of this advice matters if you don’t stick with your investment plan.
And whether or not you do depends on your investment psychology – because the right psychology is what matters most to your ultimate success.
Let me explain…
Every experienced investor you meet will agree that psychology is a critical factor in successful investing…
But I’d go even further…
I believe psychology is the only thing that matters in investing.
Now, this is not a lesson you’ll ever hear in the world’s top business schools.
That’s because (until very recently) modern financial theory completely ignored psychology.
By arguing that 100% of investors were 100% rational 100% of the time, academics simply assumed psychology away.
Psychology was a black hole no financial economist was willing to go down.
That all changed in 2002.
That was the year a psychologist, Princeton’s Daniel Kahneman (in work he did with Stanford’s late Amos Tversky), earned a Nobel Prize in economics.
Kahneman had never taken a single course in economics.
Kahneman and Tversky’s work questioned the assumption of “homo economicus,” the perfectly rational actor that was the backbone in all modern financial theory.
Together they uncovered a slew of psychological biases that make individual decision making irrational.
Unwittingly, Kahneman and Tversky gave birth to the new discipline of behavioral economics. (You can learn more about their remarkable story in Michael Lewis’ The Undoing Project: A Friendship That Changed Our Minds.)
As it turns out, even the founding fathers of modern finance are just as irrational as the rest of us.
Harry Markowitz – inventor of the infamous “efficient frontier,” a core concept in all finance textbooks – never used his Nobel Prize-winning idea in his own investing!
Of course, top investors working in the real world have long known that investor psychology trumps textbook financial models.
And you need look no further than to Warren Buffett.
Buffett described Ben Graham’s 1949 classic, The Intelligent Investor, as “by far the best book on investing ever written.”
In particular, Buffett credited Graham’s discussion of the manic-depressive “Mr. Market” as the single most important thing he had ever read. Understanding Mr. Market’s irrational mood swings gave Buffett a huge edge in timing his investments.
The world’s top hedge funds also understand the importance of psychology in investing. That’s why they employ mental health professionals to coach traders – similar to how top athletes hire sports psychologists to help them perform at the highest levels.
The late psychiatrist Ari Kiev was a mental health coach to all of SAC Capital Advisors’ top traders for many years.
In the television show Billions – inspired by the story of Steve Cohen of SAC Capital – Wendy Rhoades is the in-house psychiatrist and performance coach at the fictional Axe Capital.
So my one recommendation for you today does not involve buying a red-hot stock or ETF.
Instead, if you want to become a successful investor of money, invest your time first learning about investment psychology. (Psychologist Van Tharp’s Trade Your Way to Financial Freedom is the best place to begin.)
Psychology is rarely the place where investors start.
But it is the place where all successful ones end up.