Interactive Investor

10 lessons from the most successful everyday traders

Not every superstar investor has a name you’ve heard of. Here are 10 lessons you can take from the market’s best players.

3rd November 2023 11:28

Reda Farran from Finimize

  • There’s no single winning formula in investing – you have to find your edge and stick to it. And maintaining a trade journal can help you do that

  • Risk management on individual positions and at the portfolio level is crucial to avoiding hefty drawdowns. And if you do experience a big loss, it’s a good idea to take a break from trading

  • Try to find trades with asymmetric payoffs, avoid trades that are based on hope, and learn to distinguish between trade outcomes and trade decisions

  • Patience is key in investing: good trade opportunities are sporadic, and consistent profitability is an unrealistic goal.

Not every superstar investor has a name you’ve heard of, and Jack Schwager can attest to that. He’s spent the past 30 years interviewing the market’s best players. His latest book, Unknown Market Wizards, features the ones who – despite only ever investing in their personal accounts and never officially working in finance – have yielded better returns than the industry’s most celebrated pros. Here are 10 lessons you can take from their stories…

1. There’s no winning formula.

These traders used approaches that were fundamental, technical, a combination of both, or neither. They sometimes held their trades for months, and sometimes held them for just minutes. See, investing success isn’t about finding the right approach, but finding the right approach for you. You want the one that’s compatible with your beliefs and personality. One of the trading “wizards” started off using technical analysis but then realised he couldn’t understand why basing investment decisions off chart patterns should work. So he switched to fundamental analysis instead and had a lot more success. Another successful trader found an unconventional approach that didn’t use fundamental or technical analysis.

2. Maintain a trading journal.

A trading journal has two critical types of information: what you’re doing right and what you’re doing wrong. Keep it up to date and review it regularly to improve your process, reinforcing the former and avoiding the latter. One trader discovered from his journal that his biggest wins came from trades that shared some common characteristics. That linkage helped him work out what his edge was – and that catapulted his results.

3. Know your edge and stick to it.

The goal of investing isn’t to be an expert on every asset class and every market. The goal is to make money, and if that means having an edge in something as niche as small-cap biotech stocks, then, by all means, stick to that. If your edge is in identifying stocks poised to benefit from big thematic trends, then, once again, stick to that. Don’t be tempted to take trades outside your area of expertise just because you “should”.

4. Try to find trades with asymmetric payoffs.

The best trades are those where the potential payoff is several times higher than the potential loss. For example, one of the traders is forever searching for “ten baggers” – stocks that achieve a tenfold price increase. That potential 1,000% payoff is much greater, after all, than the theoretical maximum loss of 100% you can take when invested in a stock.

Then again, no good investor would hang onto a stock on track for a 100% loss, because virtually all successful traders have strict risk management policies in place to limit their losses. The easiest way to do that is through protective stop-loss orders, which limit your maximum loss on a trade by selling when the asset falls to a specified level, improving the payoff asymmetry. Just keep in mind that you don’t have to wait for your stop level to be triggered. If, for example, you feel your investment thesis is no longer valid after buying a stock, just sell it – you might shrink your losses in the long run.

5. Remember that risk management at the portfolio level is crucial.

It’s not enough to have stop-loss orders on individual portfolio positions – you also need to think about the correlations between your individual positions. Investments that are tightly correlated tend to rise and fall in tandem – which opens you up to the possibility that your positions could all lose money at the same time. So it’s worth thinking about adding some inversely correlated positions to your portfolio like these traders do.

6. Step back when you experience a big drawdown.

Many of the traders said they took a break from trading when their portfolios experienced a 10%-20% loss. And there are two good reasons why you might want to do the same. First, a big drawdown might mean whatever you’re doing isn’t working and that it’s time to reevaluate your process. Second, emotions tend to get in the way after a big loss, and that could lead you to make some poor investment decisions in an attempt to recover. It can be a slippery slope that leads to an even bigger drawdown – one that might be avoided by taking a break to clear your head and regain perspective.

7. If you’re hoping a trade will work, get out.

Let’s say you see some random stock or cryptocurrency that you’ve never heard of and it’s rocketing higher. And then your FOMO – fear of missing out – kicks in, and you buy it. Afterwards, you’re just sitting there hoping your new investment will go up in price, without actually having any real understanding of why it should be going up in value. If you find yourself hoping a trade will work, that’s a sure sign you’re gambling rather than investing based on a sound process. And if that’s the case, you can do yourself a big favour in the long term by exiting the trade.

8. Distinguish between trade outcomes and trade decisions.

A bad trade outcome doesn’t necessarily happen because of a bad trade, and vice versa. If a trade that you impulsively put on without following your process ends up making money, it’s not suddenly a good trade – you just got lucky. Likewise, if a trade ends up in a loss and you’re a good trader, there are only two explanations. Either you followed your process and the losing trade was within the percentage of inevitable losing trades, or you made a mistake. That happens, and you’ll own it if you’re good at what you do. Bad traders, on the other hand, will always have some excuse for why they lost.

9. Be patient.

All good traders know how to be patient. They know how to overcome the natural instincts and desires that could easily trip them up. There are two kinds of patience that are essential to investment success. First is the patience to wait for opportunities that are within your area of expertise and that fit your criteria and process. So try not to be tempted to make suboptimal trades just because nothing has come along in a while. Second is the patience to stick with a winning trade. When a trade is profitable, it’s tempting to prematurely hit the exits and take your profits. But a better strategy is to ride your winners and realise just some of the gains by selling small amounts along the way.

10. Don’t expect consistent profitability.

Opportunities come along in their own good time. If you aim for consistent profitability when opportunities are scarce, it can work against you, leading you to make trades that end up losing money. That’s what makes investing for a living so difficult: profits are inherently volatile and losing periods happen, even when you need to pay your rent. So if you’re thinking of quitting your day job to trade, maybe don’t…

Reda Farran is an analyst at finimize.

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