In my last article I wrote about the importance of having a game plan. The responses I received made it clear that there was a preliminary step that needed more attention.
And that is, golden handcuffs need to be removed before opportunities are realized. Golden handcuffs are influenced by the investment industry and psychological dogma, and they are prohibitive in volatile market conditions.
Golden handcuffs keep you from being objective, and in volatile markets, when downside market moves are as big as upside moves, an objective approach can allow you to make money even when the market declines. In these new market conditions, opportunities lie in objective and proactive strategies, and when we remove the golden handcuffs, it helps open the door for opportunity.
Read: Here’s why bonds might not be a haven in a trade war
Overconfidence
An example of a golden handcuff is when an investor does hours of research on a company, studies its products, learns about the competition, can see the market for the products and spends time contemplating an investment decision. And then he finally buys it with confidence.
The first reaction to traditional doctrine is: “That’s the way it should be. Invest with confidence!”
However, this approach can cause investors to hold on for too long. Imagine doing all the research on Expedia EXPE, +2.81% in January, a stock that was up about 150% from early 2014 before it pulled back slightly, presenting a buy-the-dip opportunity. The online-travel company seemed likely to be a direct beneficiary of the Trump tax cuts too. Travel increases when people get more money in their pockets, so the theory goes. Your confidence is high, you have done your homework, and you expect this to be a good decision.
You even looked at the technicals and economic data, and saw nothing concerning. Everything you did was responsible, how it should be. Your intention was to do exactly what traditional doctrine suggests, and that is to buy and hold the stock. Then it fell as much as 20% intraday as the company’s earnings trailed analysts’ expectations.
Good companies can decline too
I used Expedia as an example, but the same could be said of Walmart WMT, -1.48% and Biogen BIIB, -0.50% too. When was the last time you saw such declines in good companies? Things are changing out there; the stock prices of good companies can decline, and the company can still be great, and that is something very few people remember. Central bank stimulus is over, and liquidity is drying up. You need to remember those things.
Stock prices of good companies can decline too, but after an investor does all that work to research the investment, it’s hard to pry the stock from his hand. Even in the face of bad news, he will hold.
Part of this is because investors are human, and as humans, we always want to be right. There’s another way: Instead of doing all the work to research a stock, why not just invest directly in the S&P 500 Index SPX, -0.05% using the SPDR S&P 500 ETF Trust SPY, -0.04% There are three reasons for this.
1. SPY has beaten most managers and mutual funds over time.
2. Investments in SPY require far less time and research.
3. SPY is an ETF (exchange traded fund); we don’t have emotional ties to it.
The ETF has no product, no company stats to study, and all we need to do is the economic and technical portion of our research to make a decision. Most of the work is no longer needed when we invest in a market instead of a stock. We also have no ties to it, and that increases objectivity. We have no manager to like, no products to like, and no vested interest.
That makes it much easier to control risk. But something else starts to happen when you start to control risk. You also start to outperform, you start to become more objective, and soon afterward you might even make money using a proactive strategy.
The process to realizing the opportunity this new market offers seems to start with realizing that you are able to control risk. Yet, it’s really about removing golden handcuffs. We need to remove our emotional ties and reduce absolute adherence to traditional doctrine. This market has changed, and we now need to be objective, if not for making money, at least for protecting assets.
Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily.