Monday, June 16, 2014

Bulls make money and bears make money, but pigs get slaughtered

The following story is a great example that can applied to trading and a willingness to sell when you only have a small decline.  It is quoted from the book, The Psychology of Speculation by Fred C. Kelly.  I also use this example in my book, Buy and Hope which you can 'Look Inside' at Amazon here

A little boy was walking down the road when he came upon an old man trying to catch wild turkeys. The man had a turkey trap, a crude device consisting of a big box with the door hinged at the top. This door was kept open by a prop, to which was tied a piece of twine leading back a hundred feet or more to the operator. A thin trail of corn scattered along a path lured turkeys to the box.
Once they were inside, the turkeys found an even more plentiful supply of corn. When enough turkeys had wandered into the box, the old man would jerk away the prop and let the door fall shut. Having once shut the door, he couldn't open it again without going up to the box, and this would scare away any turkeys that were lurking outside. The time to pull away the prop was when as many turkeys as one could reasonably expect were inside. 

One day he had a dozen turkeys in his box. Then one sauntered out, leaving 11. “Gosh, I wish I had pulled the string when all 12 were there,” said the old man. “I’ll wait a minute and maybe the other one will go back.” While he waited for the twelfth turkey to return, two more walked out on him. “I should have been satisfied with 11,” the trapper said. “Just as soon as I get one more back, I’ll pull the string.” Three more walked out, and still the man waited. Having once had 12 turkeys, he disliked going home with less than 8.

He couldn’t give up the idea that some of the original turkeys would return. When finally there was only one turkey left in the trap, he said, “I’ll wait until he walks out or another goes in, and then I’ll quit.” The solitary
turkey went to join the others, and the man returned empty-handed.
The psychology of normal investors is not much different. They hope more turkeys will return to the box when they should fear that all the turkeys could walk out and they’ll be left with nothing.

The point is, you need to have a definitive answer as to when it is the right time to enter the market, and the right time to exit, but the duration will be different every time.  Bottom line is that if the trade is working out, and you are making money … then you stay invested.  As we saw in 1998-1999 and somewhat so in today’s market in 2013, regardless of the worry in the news … a market can continue higher much longer than anyone can predict. 

So you let the market tell you when its’ time to exit.  You don’t decide, the market decides for you.  As long as it is acting healthy you stay invested enjoying more and more profit, but as the market starts to change its’ character and roll over … starting to decline, you exit quickly and lock in your profits.  It doesn’t matter that the market only dropped 2% from the high and people on TV are saying its’ a bargain now … you exit.  The first sign of weakness is your sign to say goodbye.

And the same is true for when it is time to get back in.  The rules we have setup will tell you when to enter the market, to maximize your potential.  You need to follow the rule and not second guess it.  Usually when things look most grim we are at the moment in time when the greatest profit is possible, this is why Warren Buffett has don’t so well in his investing career … he buys beat down companies when every one else is running for the hills, and holds them until everyone else is euphoric about them.  Using rules keeps you from second guessing your entry (or exit) … regardless of what you are seeing on the news or hearing from your friends.

“Bulls make money and bears make money, but pigs get slaughtered” - Unknown

Don’t be a Pig, don’t hesitate an entry or an exit.  Remember you will be wrong sometimes, but all that matters is that in the end you make money.  An exit at a wrong time means you miss out on some profit, but an exit at the right time means you will miss out on a large decline … which would you rather?