The Biggest Decision for the Individual Investor

The most important decision for individual investors is what to do for themselves.  Various studies show that  individuals, on average,  attain about half of the overall market return when trading their own accounts.  The main reason is that they make poor timing decisions.  They overestimate their own capabilities and underestimate the difficulty.

It Seems So Easy

Technical analysis is deceptively easy.  In an outstanding article, Pradeep Bonde writes as follows:

Chart reading is a long enduring cult in the market. Beginner traders
are quickly grabbed by the simplicity of charts reading techniques and
chart patterns. They waste countless hours and years perfecting chart
reading and making sub optimal returns. Many get so lost in the technical analysis jungle, that they never find profitable way out of it.

Read the entire article and follow the links  for a full understanding of the message.

Advertising by major brokerages encourage the individual investor to believe in market "feel" and to have confidence in making decisions on this basis.  We have written about  how this leads to mistakes during scary times and distracts people from the key fundamentals.

It is in the interest of online brokers to encourage individual trading.  Beware of messages that make it seem too easy. 

What is Required

Good investing requires intelligence, knowledge, method, discipline, and psychology.  In various articles, we have covered each of these topics.

Even this formidable collection of attributes is not enough if the investor is unwilling to make a significant commitment of time.  David Merkel, in his excellent series (check out the other parts also) for the individual investor, writes wisely as follows:

People come and ask me for investment/financial advice.  My first question is:

How much are you willing to learn, and how much work do you want to do?

Jim Cramer frequently advises investors that they must expect to spend one hour per week per stock in their portfolio.

Conclusion

We wonder how many investors are really willing to do the necessary work.  The intelligent investor may be the  most easily trapped, thinking that it is all pretty easy.  Those who have initial luck — a hot tip or source, an excessively large position in a stock that makes a good move — are the most vulnerable.

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2 comments

  • Pradeep Bonde December 10, 2007  

    Thanks.
    The seductive charm of Technical analysis is hard to resist for most retail traders and investors.

  • Mike C December 11, 2007  

    Just an opinion, but I think technical analysis is just another tool in the toolbox along with fundamental and quantitative analysis. Unfortunately, I do think it is sold/marketed to newbies and novices as the easy way to get rich in the stock market. Having said that, I do think one can use this tool to increase the positive expectancy of one’s overall decision making. I think this blogger has an interesting take on technical analysis:
    http://runningofthebulls.typepad.com/toros_running_of_the_bull/2007/12/momentum-beats.html
    “I am a value guy. I entered this business as a hard-core value investor. I read books about value investing when I was in undergrad. I worked at a highly-regarded value shop. I have always believed that buying undervalued securities was the best way to generate substantial returns.
    When I left MBA, I was completely disdainful of technical analysis, and loathed momentum investing – “mindless momentum” or “mindless momo” I would derisively refer to the strategy. However, as I became completely absorbed by the market, I began to notice that certain chart patterns seemed to repeat themselves.”
    Me personally, I use both FA and TA although the majority of the decision is always based on fundamentals and valuation, and the technical analysis is just a supporting point and used to better time entries and exits. I’ve used technical analysis as a supplemental tool to both increase the probability of identifying winners and avoiding losers. My decision to buy and hold Berkshire over the past couple of years was due in part to a favorable chart pattern (breakout out of a long consolidation pattern) and it is up 65% over 2 years and 40% over 1 years. I held a substantial winning position in REITs for about 3 years, and sold the majority of the position in May 2007 due to technical reasons such as broken trendlines and multiple other technical sell signals. REITs have declined substantially since that point in time. For the record, for me, it was more important that the fundamental valuation on Berkshire was attractive, and the REIT valuation was unattractive.
    Agree with Jeff completely that decisions have to be based on a rigorous and disciplined process and not on “feel” or “hunches”, but I see no reason TA can’t be part of a discplined process.