Keep journal to make better investment decisions

In my recent travel, I met Mike who's doing a PHD in analytical psychology. Over the course of our discussion, he did mention about his recent interest in stock trading. He felt that the very low interest rates the bank offered made him to pivot to stocks to make better returns from his surplus money. This was in Jan/Feb of 2021 when the meme stock euphoria was catching up. His work with academics led to create a small python-based program that analyzed the sentiment of stocks from the social media feed.

Accordingly, he had taken exposure in some of the stocks which began to gain momentum and eventually he made seven times returns in one of the stocks. He was happier with the find but didn't profit book or reduce his exposure as the same analysis had pointed out a further possible increase in the stock price. Over the period as the market conditions changed and the sentiment veined the stock prices corrected though he's still at a handsome profit over his purchase price. Like any individual he felt that he could have realized part of the gains though he didn't set them off as that would attract the capital gains taxation.

He asked on how to approach such situation. After listening to his story, I asked to him to document the entire episode. Make a journal of his journey from identification to actual trade and the reasons why he persisted with the stock. I suggested him to do it when the memory is still fresh which he promised would do it as soon as he got off the plane. I continued that for any investment or even a trade, one needs to set rules, rules that the person abides by. This helps in defining the boundaries of the various trades one makes, the risks, the return expectations and the action plan after reaching the desired levels.

This needn't be mimicking anyone's strategy as it would serve as a personal guide to maneuver the market. For instance, what should one do when the stock or the overall market corrects by a particular percentage? Would they buy more or reduce exposure or remain invested and if they were to change the exposure, how much should they do it? This might sound similar to what a risk profiler questionnaire suggests but the answers to these questions act as guiding principles and allow one to draw boundaries, beyond which an action is chalked out.

In a way, this would become the personal risk profile helping one to allocate sums accordingly. That pulls out the dilemma of what to be done at various market conditions as there are pre-defined guidelines of action. Thus, this requires one to set target prices and stop-losses for each of the securities. The target, however, could be in the form of the stock price or even a period depending upon their risk profile. The stop-loss could trigger one to exit or reduce the exposure and in some instances an opportunity to add further if they carry a higher conviction.

At the latter situation, one must be aware of the allocation proportion with respect to the rest of the portfolio. Averaging downwards would end up over allocating to a particular security skewing the overall risk profile of the portfolio. That would turn counterproductive upsetting the very reason for creating such an action plan at the first place. The purpose of this broad set of rules is to reign in emotions which supersedes rationale during volatile periods like that of now.

Though long-term wealth is created by time spent in the market than timing the market, this exercise serves one to remain stoic during testing times of the market. Not everyone is fortunate like Mike, to have realized the folly while the fresh wounds help him to revisit the emotions attached during the recent episode of decision making or indecision. By making a note of these circumstances which led him to make such decisions, it allows him to get prepared when similar situations arise in the future. Though past circumstances may not be repeated, the experience gained would certainly provide wisdom if one prepares to learn from them.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at [email protected])