Saturday, November 6, 2010

Which come first? Making profit or making loss?

To have profit, first you need to make a loss!

It may sound bizarre but the first step to making a profit in the stock market is to make a loss. Not a real loss, but what’s called a paper-loss. This means that you must expect any investment you make to go down over the short-medium period, but in the long term it will generate a profit. All this is not just some fancy theory, but something based on a hardcore study of numbers and investor psychology.

You may do a great amount of research work and put in hours to come up with an investment strategy and the investment-based financial planner whom you engaged may offer you investment advice, while this is good discipline, it by no means guarantee success. Making sustainable profits from investment depends on endless factors, some predictable and others totally unforeseen. So, how do you ensure a good investment growth over long-term?

When you make an investment, you should be prepared not to expect any positive returns for the short to medium term. In such a case of uncertainty, expectation is what is considered the most likely to happen. Expectation is a belief centered to the future and it might or might not happened. More often than not, investors tend to feel disappointed when they do not expect the unexpected. So expecting loss before gain will go a long way. Only beyond that, the returns will start to roll in. According to Newton’s law of gravity, what goes up must come down, what goes down must come up, except for one’s age. Expecting loss or "Loss expectation" is an important psychological step to cross a bear market, when things are less rosy and negative markets overrule.

Bull markets can sometimes send you the wrong signals and lead you to think that the markets will never disappoint you. And, often investors get into without asking the right questions hoping to make quick profits. Then psychological expectations grow out of proportion and greed gets the better of them. Investors would end up holding the investment assets against unnecessary risks. And when the markets crashes without warning, it may be too late to exit (The Lehman Brothers) without getting burnt. One way is to adopt the “ERP” approach when various investment opportunities are evaluated. As an intelligent and informed investor you should not only be motivated by (P)erformances, but also be aware of taking calculated (R)isks and the cost of maintaining the investment or the (E)xpenses incurred. Buying into an overly bullish market is clearly not based on taking calculated risks.

On the other hand, when the market is more bearish, you could be able to identify the potential value in the capital market. Due to the less optimistic investing environment, you need to adopt a more practical return growth path and accept a realistic practical return growth path. Your main focus is on the recovery and how you can ride on it. What we want is the return and not to be stuck with those fund that is not performing. Hence, the most important strategy is to buy only fundamentally sound diversified investments across asset classes, geographical regions and funds of reputable fund managers with strong investment ratings.

Getting over a negative state of mind through loss expectation is very important in a bear market. You should hold on to fundamentally strong investment assets on a long term basis and be prepared to take in the “paper loss” arising in the short term and mid term.

Always remember, successful investors are in control of their emotions and are more likely to act on facts as opposed to feelings. Patience and perseverance are two essential traits during a bearish market. If you are able to handle losses emotionally and come out of it, you would have more flexibility and adaptability to handle future uncertainty better. Even the best investment selection system would lose money if you do not have the right attitude, so develop a positive one. Always have a long term view, this is a sound investment strategy and has been proven to be successful towards building and preserving your core wealth.

So be prepared and expect for small loss to gain BIG profit!

Related articles: Adjusting our mindset to avoid common behavioural pitfalls.