Common Avoidable Mistakes Made By Investors And, Sadly, Even By Analysts

Sunday, January 8, 2017

investment charts

Based upon the recent larger than usual growth in my membership at Elliottwavetrader.net, it would seem that other membership sites may have had some difficulties of late, from which we have benefited.  This often happens when we see big moves in markets that others may miss and that we usually have foreseen. 

But, this time, there is one particular site that seems to have almost blown up due to the lead analyst’s failure to adhere to any of the advice and common risk management strategies I present below.    While we have grown due to this situation, I would much rather not grow due to others hurting.  But, even the most novice of investors must learn these lessons early on, or they will learn them the hard way only after they blow up their account. So, let’s try to outline what each of you can do so that you can protect yourself in the future.

First, you must always have some form of risk management strategy in place. While there are many methods one can chose to use – puts, covered calls, selling all or a portion of your underlying position, using stops, etc. – one must always have a risk management plan laid out well before you need it.  You see, an investor must view their job similar to a marathon rather than a sprint.  You must realize that you will be wrong at times along the path of your investment career, and what you do when you are wrong will determine if you will or will not have a successful long term investment career.

Second, you must avoid using products like 3X leverage funds.  These funds are designed to go to zero.  They lure investors in with the potential to make outsized gains, but have only proven the old adage that “bulls get fat, bears get fat, but pigs get slaughtered.”  For this reason, you must realize that these funds are NOT INVESTMENT VEHICLES, but are only trading vehicles.  Anyone suggesting you use one of these vehicles as an investment vehicle is to be viewed as dangerous and lacking in any understanding of the vehicle or the market itself.

Third, there is another old adage that states that one “should not put all their eggs into one basket.”  As an investor, it means that, even if you like a particular sector, you should NEVER put more than 15% of your portfolio into any one sector at any time.  Also, one should never place more than 3-5% of your portfolio into any one stock either.  These are simple risk management principles that every investor should consider adopting, and it will help you to stay in the marathon we call long term investing.

Fourth, many use options like they use 3X ETF’s.  Too many investors use options from a gambling perspective, and usually go too far out of the money, only to find their price targets eventually get hit, but time has run out on their options.  Unless you have a truly detailed and deep knowledge of how options work, I would avoid using them.  But, if you want to learn more about options, or are interested in a tool to help you pick the optimal strike for your trading strategy, I highly suggest gammaoptimizer.com.

Lastly, you must realize that any analyst you follow is human, and subject to human frailties.  Moreover, financial markets are non-linear systems.  Based upon these two facts, it is simply impossible for any analysts to be right 100% of the time.  If you find an analyst that is correct 70% of the time, then you have found yourself one of the best analysts in the world, assuming he practices appropriate risk management strategies.  Consider that even the most amazing analyst that is right 70% of the time can blow up your account during the 30% of the time they are wrong.

Now, along the same lines, if one simply wants to play at trend, then one does not really need an analyst at all.  Rather, the true benefit of following an analyst is for their ability to identify an impending trend change.  So, if an analyst tells you to simply buy at any point and a “bull market will correct any timing mistakes,” you should run the other way.  This means that this analyst has no risk management in place, is unable to identify trend changes, and is simply guessing and “hoping” the market will turn again in his favor.  Any analysts who takes this perspective is not merely wrong, but simply gambling with your money.  Moreover, when you think about it, does one really need an analyst who suggests you can buy at any time, without stops, and be ok?  Do you need to pay for “advice” like that?

As a real-life example of what not to do, there was a “call” I saw in 2016 which suggested to buy a 3X ETF when it was around 25, without any stops, and using up to 25-50% of your portfolio.  This is the epitome of doing everything wrong.

Sadly for those investing their hard earned money based upon that “call,” that 3X ETF hit a low recently of 3.77.  For those counting, that is an 85% drop in price, and it was catastrophic to those who followed this call.  Moreover, based upon the way these 3X ETF’s are calculated, the underlying market will have to rally significantly higher than the point at which this “investment” was made in order for those who bought into this suggestion to even break even.

As you can see, this suggestion broke every principle I have learned as an investor, and outlined above.  First, one should NEVER buy a 3X ETF as an investment, as it is a trading vehicle and not a buy-and-hold vehicle.  Any knowledgeable advisor or market analyst would know this, and if you see an advisor suggesting otherwise, PLEASE recognize that he is suggesting that you gamble with your money.   Second, this market call did not advise stops, since the belief was that the market would correct any bad timing entries, and that the “manipulators” would take your stops. Well, I think we can all see why not using stops was catastrophic to those following this market call.  Third, the “advice” of investing as much as 50% of one’s portfolio into any one vehicle or sector is also another form of gambling.  And, to suggest that large of a position using a 3X ETF without stops is even worse than gambling . . . it is reckless gambling.

Each and every one of you have a responsibility to yourself, your future, and your families’ future and should not be taking needless risks in an already difficult financial environment. If you follow some simple risk management strategies, and stay away from 3X ETF’s for investment purposes, you give yourself a much better chance of finishing this marathon by avoiding any catastrophic set-backs, from which it could take years to recover.

May 2017 bring you and your families much happiness, prosperity, and, most importantly, good health.

 

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Avi Gilburt

Avi Gilburt is a widely followed Elliott Wave technical analyst and author of ElliottWaveTrader.net (www.elliottwavetrader.net); a live Trading Room featuring his intraday market analysis (including S&P500, metals, oil, USD & VXX); interactive member-analyst forum; and detailed library of Elliott Wave education. Visit his website:https://www.elliottwavetrader.net. You can contact Avi at info@elliottwavetrader.net.