Posted on July 19, 2008 - by andrew

Big losses makes you a more disciplined investor

At some point all of us have heard that it takes discipline to become a successful investor.  Disciplined investing usually refers to how well an investor follows the rules of his trading strategy. Most of the time, however, this discipline only comes after making big mistakes and taking big losses.

The trading strategy I follow is CAN SLIM. It emphasizes a few key rules:

1. Only buy stocks during a market uptrend (i.e. not when the market is in a correction).
2. Only buy stocks breaking out of sound bases (or patterns) on strong volume (i.e. volume that is 50% or greater than the stock’s average daily volume).
3. Do not buy a stock that has risen 5% past its buy point.
4. Sell all stocks that go down 8% from your purchase price.

These trading rules sound easy enough to follow, right? However, this is usually the furthest thing from what actually happens with most investors. As I’ve learned, being a disciplined investor and sticking with the rules religiously is not easy for most people.

The single factor that influences your decisions the most is money. When real money is to be made or lost, your emotions affect your trading and investment decisions. I’ve often found myself breaking the CAN SLIM rules listed above repeatedly. Here’s what typically goes on in my head when I break a rule:

1. I can bend the rules because this time is different
2. I can get a jump on everybody else if I make my trade now (i.e. Buying before the stock reaches a proper buy point)
3. I’m down, but I have a great feeling about this stock and it’s gonna go back up.

I’ve made so many bad trades over the years from acting on impulse and emotion. Afterwards, I review each bad trade to try to figure out what I did wrong exactly. Then I just tell myself that I just won’t make the same mistake in the future and hope that I don’t do it again…

But I realized recently that the only way to truly learn your lesson is to lose a lot of money on a poor trade. You have to get burned before you learn not to play with fire.  I would make the same mistake over and over again and not learn my lesson. Then I find that I eventually make that mistake again, lose a ton of money and have a bitter taste in my mouth for a long time.

When a similar situation arises again, you’ll go back and remember what it was like to have lost so much money. The perfect example of this for me is when I was buying Jones Soda (JSDA) in the summer of 2007. I had been buying JSDA at improper buy points. On top of that, I was averaging down in my position (i.e. buying more of the stock as it went down in price) because I was gambling on the hope that they would report great earnings.

Eventually, I was down as much as -20% when I finally decided to sell Jones Soda. I had lost way more than the -8% loss I should have limited myself to. On top of that, I realized why it was so bad to average down and buy at improper buy points.

In conclusion, developing discipline when it comes to following a trading/investing strategy takes a while for the most of us. As you make the same mistakes repeatedly, hopefully you eventually get burned so bad that you never make that same bad trade again. Treat your loss as a valuable, expensive lesson on the way to becoming a disciplined, successful investor.

If you are interested in learning more about CAN SLIM, visit the Learning Center on Investors Business Daily.