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How to Win the "Loser's Game" of Investing...By
Friday, June 13, 2014
Last Sunday, Rafael Nadal won the French Open title, earning his 14th overall major championship...
The victory gives Nadal an unprecedented run of nine French Open victories in 10 years... In most fans' eyes, it solidified him as the best clay-court tennis player ever... and one of the all-time greats, regardless of surface.
As an investor, you probably don't care THAT Nadal won. But you need to understand HOW and WHY he won.
It might surprise you, but tennis and investing share one major characteristic. And if you don't understand it, you could end up losing a LOT of money.
Let me explain...
Tennis isn't a single sport. It's actually two different games, depending on who's playing. When professionals – like Nadal – take the court, tennis is a "Winner's Game." But when amateurs play, tennis becomes a "Loser's Game."
Simon Ramo explains the fine details in his book, Extraordinary Tennis for Ordinary Tennis Players. His overall findings are incredibly simple...
When the professionals face off, the winner of the match determines the outcome. In amateur tennis, the loser determines the outcome.
You see, professionals tend to make fewer errors and hit more winners. Ramo found that professional tennis players tend to earn around 80% of the points. They only lose around 20% because of mistakes.
Amateur tennis is exactly the opposite... Ramo found amateurs tend to lose around 80% of their points. They only earn around 20%.
He used these simple ideas to develop a winning strategy for amateur tennis. Play conservatively. Keep the ball in play. Allow your opponent (who is almost surely an amateur) to make errors. He will.
Sure, he'll make a great shot or two. But over the course of a match, he'll try to beat you by winning. And he'll fail. He has no idea that amateur tennis is a Loser's Game. But his constant losing decisions will easily allow you to win the match.
Investing is a lot like amateur tennis. It's a Loser's Game...
There's a reason so few institutional investors beat the overall stock market. They spend all of their time focused on winning. They're constantly playing offense. They don't even consider playing defense.
Sure, there are a few Warren Buffetts out there. There are a few brilliant managers who find areas to exploit and consistently win. But most professional managers who constantly play offense end up losing...
According to Standard & Poor's (S&P), 63% of actively managed mutual funds failed to beat their benchmarks from 2008-2012. Amazingly, 84% failed in 2011 alone!
Now, I'm not saying you should give up, buy an index, and be done with it. But you need to focus on playing defense.
There are two simple ways to play great defense as an investor... by applying them, you'll eliminate two of the most common mistakes investors make.
The first is knowing when you'll sell. And a great way to do that is with trailing stops.
Trailing stops are a simple way to avoid catastrophic mistakes and losses in your portfolio. If you set a 25% trailing stop, the most you could ever lose is 25%. You're ahead of most managers just by focusing on your max loss... by playing defense. (You can go here for a full explanation on trailing stops.)
The second defensive tool is never putting too much money into a single idea. A simple rule is using a max of 5% of your portfolio in a single investment. This prevents one bad trade from spoiling your entire portfolio.
Remember, we're not playing professional tennis. We're playing amateur tennis.
Investing – for the most part – is a Loser's Game. Don't spend your time playing offense and trying to win. Focus on playing defense... by using trailing stops and proper position sizes.
These two ideas will protect you from the biggest mistake an investor can make – catastrophic losses. And avoiding mistakes is how you'll win the Loser's Game of investing.
Good investing,
Brett Eversole
Further Reading:
"Diversifying your portfolio is the key to avoiding catastrophic losses," Dr. Dave 'Doc' Eifrig writes. "With one stock, you can win big. But you have high risk. You could lose it all. But as you own more and more stocks, your risk goes down." Learn how to start diversifying your portfolio today right here.
Porter Stansberry says most investors will not make money on their investments this year... or next year. Most investors, in all likelihood, will never make money in the stock market. "The only chance you've got to become a successful investor is to start by acknowledging that reality," he writes. "Once you know that individual investors generally fare poorly in stocks, you can begin to examine why..." Get all the details here.
Market NotesA DIVERSIFIED WAY TO GET LONG FRACKING It's a bull market in fracking. That's the idea in today's chart.
By now, you've probably heard how the drilling innovation known as "fracking" has allowed us to access vast amounts of oil and gas in the United States. Oil production has grown at double-digit percentage rates for the past three years... and overall production recently hit its highest level in more than 20 years.
This is good news for the companies contained in the S&P Oil & Gas Exploration & Production Fund (XOP). Unlike many energy-investment funds, XOP isn't weighted toward giant energy firms like ExxonMobil and Chevron. Instead, it's heavily weighted toward smaller exploration and production outfits. These kinds of outfits are small enough that they can see 20%... 30%... even 50% annual increases in production.
As you can see from the two-year chart below, business is good for smaller exploration firms. XOP has fracked its way from $45 a share to $78 per share (a 73% gain). Just yesterday, the fund hit a new high. It's a bull market in fracking!
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