horsepower allows us to explore enormous numbers of potential trading rules. If you look long enough, you will no doubt find rules that work great over the test period, but are not necessarily so good for other periods.
8. There is a tradeoff between quantity and quality.
Suppose you are developing trading rules based on technical analysis. Rule A says to buy when pattern X occurs. Rule B says to buy when pattern Y occurs. Will combining A and B lead to a really great trading rule? Perhaps. However, the combination rule may occur so infrequently that it is not as good as simply buying whenever either A or B is applicable.
9. Consider using a portfolio of rules.
Another way to diversify is to use a portfolio of rules rather than a single rule.
10. Decide in advance when to bail out.
In a way, the question here is similar to that raised in rule 1. What will you consider proof that your rule is not working?
‘Since 1950 an excellent strategy has been to invest in the market between November 1st and April 30th each year, and then to switch into fixed income securities for the other six months of the year.’
Yale Hirsch
Gary Belsky
Gary Belsky was a writer at Money magazine from 1991 to 1998. From 1994 to 1998 he was a regular weekly commentator on CNN’s Your Money and a frequent contributor to Good Morning America, CBS This Morning, Crossfire and Oprah. He is currently a deputy editor at ESPN The Magazine.
In 1990, Belsky won the Gerald Loeb Award for Distinguished Business and Financial Journalism, administered by The Anderson School at UCLA. He lives in New York.
Books
Why Smart People Make Big Money Mistakes and How They Correct Them (co-authored with Thomas Gilovich), Fireside, 2000
ESPN the Magazine Presents: Answer Guy: Extinguishing the Burning Questions of Sports with the Water Bucket of Truth (Brendan O'Connor, Neil Fine), Hyperion Books, 2002
23 Ways to Get to First Base: The ESPN Sports Uncyclopedia, ESPN Books, 2006
Behavioral finance
1. Every dollar spends the same.
People tend to treat money differently depending on where it’s come from. They spend money received as a gift, bonus or tax refund freely and easily, while spending other money - money they’ve earned - more carefully. Try not to compartmentalise your money in this way. Treat it all the same. One way to do this is to park ‘found’ money in a savings account before you decide what to do with it. The more time you have to think of money as savings - hard-earned or otherwise - the less likely you’ll be to spend it recklessly.
2. Control your fear of losses.
A bedrock principle of behavioral economics is that the pain people feel from losing $100 is much greater than the pleasure they get from winning $100. Be careful that this does not lead you to cling on to losing investments in the hope that they’ll return to profit, or to sell good investments during periods of market turmoil when holding them would be better in the long term.
3. Look at decisions from all points of view.
Too many choices make choosing harder. If you suffer from ‘decision paralysis’ try looking at the options from a different perspective. For instance, if you are trying to decide between different stocks or funds, imagine that you already own them all. Your decision then becomes one of rejection (“which one am I least comfortable owning?”) rather than of selection, and you may find this helps.
4. All numbers count, even if you don’t like to count them.
The tendency to dismiss or discount small numbers as insignificant - the ‘bigness bias’ - can lead you to pay more than you need to for brokerage commissions and fund charges. Over time, this can have a surprisingly deleterious effect on your investment returns. Avoid this ‘bigness bias’. Count all the numbers.
5. Acknowledge the role of chance.
A failure to fully grasp the role that chance plays in life leads many investors to be overly-impressed with short-term success and other random or unusual occurrences. Thus, many investors pour money into mutual funds that have performed well in recent years under the mistaken belief that the funds’ success is the result of something other than dumb luck.
6. Your confidence is often misplaced.
Nearly everyone falls prey, at some time or another, to an overestimation of their knowledge and abilities. Most dangerous for investors is the delusion that, with a little knowledge or homework, you can pick investments with better-than-average success. In reality, there is little reason for even the most sophisticated investor to believe that she can pick stocks - or mutual funds - better than the average man or woman on the street.
7. It’s hard to admit mistakes.
This sounds basic, but we’re not talking about pride so much as the subconscious inclination people have to confirm what they already know or want to believe. Because of this ‘confirmation bias’ it’s important to share your financial decisions with others - seeking not only specific advice, but also critiques of your decision-making process.
8. The trend may not be your friend.
In the long term, conventional wisdom is often on target - as it has been over the past 25 years in the trend away from fixed income investments towards stocks. In the short run, however, the vagaries of crowd behavior - particularly ‘information cascades’ that result in dramatic shifts in tastes and actions - frequently lead to costly overreactions and missed opportunities. Treat trends and fads with skepticism and caution.
9. You can know too much.
Knowledge is power, but too much ‘illusory’ information can be destructive. Studies have shown that investors who tune out the majority of financial news fare better than those who subject themselves to an endless stream of information, much of it meaningless.
10. Don’t check your investments too regularly.
The less frequently you check on your investments, the less likely you’ll be to react emotionally to the natural ups and downs of the securities markets. For most investors, a yearly review of their portfolios is frequent enough.
‘There is no such thing as a ‘hold’ decision. If you wouldn’t buy the stock again today, assuming you had additional money, you should either sell, or admit that you are confused.’
Robert V. Green
