Chapter 2

Relationship Investing

I have always believed that you must treat your investments in the stock market as you would treat a personal relationship, and this is the central theme of my book: relating the stock market to relationships in your life. For example, if a couple is dating for a period of time and their relationship sours to the point where they can’t stand one another anymore, are they going to get engaged, marry, buy a house, and have kids together? Of course not! The relationship would be severed immediately. But what seems like such a clear-cut choice in life is often far murkier when it comes to investing in the stock market—where money, egos, and emotions can combine to do funny things to people and make them act in ways often detrimental to their investment health.

For example, time and time again the worse a desired stock acts and the cheaper it gets, the more excited some market participants get about owning it. Not only do they establish new positions in the shares, but those who already own the stock at higher quotes commit an even greater investment sin: they “average down” the already losing position (meaning they buy additional shares as it declines in price). Unfortunately, the result that this “buy more when it acts poor” strategy usually achieves in declining markets is a compounding of losses and extra tax loss carry forwards at tax filing time. Again, it’s like dating that person with whom you have nothing in common, really can’t stand, and argue with frequently, yet propose to, marry, purchase a home, and have kids with. It’s almost as if you need to justify remaining in a poor relationship or holding a losing equity position on the grounds that you’ve already got so much time or money “invested” in that endeavor. It’s a bad excuse, however, and offers nothing constructive in terms of reversing those negative situations. You need to know when to sever a relationship, whether it’s personal or monetary or business related.

I also realize there’s an aversion to adding to an equity position as it rises in price, fearing that you’re either paying too much or buying the position at what will prove to be at or near its price peak. But in keeping with our relationship investing theme, if you purchase a stock and it proceeds to rise, the market is proving your thinking correct so far. Aren’t you then wiser to consider buying more shares of a stock that’s confirming your viewpoint and rising in value (and most importantly in this author’s view, acting well from a technical analysis standpoint) than in adding additional, hard-earned capital to a stock that’s showing you a loss? This type of investment thinking also helps significantly when it comes to risk management considerations and the setting of “stops” (predetermined orders to buy or sell a security, which I’ll discuss later). Selling your stock market winners only because they show you a profit is like refusing to continue dating someone whose company you thoroughly enjoy. Why sever a potentially winning relationship? It’s like telling that person “things are going well, we’re getting along and enjoying each other’s company, so let’s break up.” Penalizing either just because they’re showing positive results makes no sense. While there are reasons you might want to pare a profitable stock position—such as a potentially weakening chart pattern—unease with it comprising too large a portion of the portfolio’s value, or some other consideration, to use the fact that it’s showing you a profit as the sole criteria for its sale isn’t part of this analyst’s discipline.

You’re far better off taking the time to analyze your errors so you can try to correct them than in putting a lid on how good something can get. So spend plenty of time analyzing and revisiting your losing trades because, as with a relationship, ignoring your mistakes won’t make them disappear. In fact, it only assures their continuance. Unfortunately, this task isn’t practiced enough. Remember that a stock must prove itself worthy of attracting your hard-earned investment capital for purchase. It does that by acting well overall, not poorly.

Make no mistake about it; investing is a difficult business. It tries your patience and tests your emotions. In many cases, simply accepting the conventional market wisdom doesn’t work. By relating situations in the stock market to those in our everyday lives, I find that people have a common denominator that assists them in the always difficult task of investment decision-making.

Moral: By comparing the stock market’s ups and downs to equivalent situations in our everyday lives in areas like dating, marriage, parenting, and business, you’ll be better able to relate to the tenets of technical analysis in nontechnical terms. This should help you become more closely aligned with the market’s rhythm and remove some of the complexity and anxiety from the investment process. There’s obviously considerably more detail to the business of investing than implementing this technique, but I think it’s a highly useful initial step in beginning to alter, and hopefully improve, your investment approach.