Last week I wrote about a couple of pesky little monsters that cause all kinds of problems for everyday people like you and me. Now that you know about Fear and Greed and what they do to wreak havoc on investors and their accounts, what do you do about them? This is the big question that every investor has to answer. To a certain extent, this is an individual question – there is no one single solution that applies equally to everybody. The only way to answer this question in an individualized fashion is through trial and error. As you start investing, you will come up with your own methods of dealing with these rascals. There are a few things to keep in mind as you get started that you’ll find to be helpful.
Knowledge is Power
The first key is knowing that Fear and Greed are always there, twenty-four hours a day, seven days a week. You’ll probably never get rid of them, but knowing what they do, and when they try hardest to influence the decisions you make will go a long way to helping you know how to minimize their damage.
An example of this for many investors comes after making a mistake. You thought a stock was going to go up – but instead it dropped big time right after you bought it. How do you react? If you know that Fear and Greed are both going to start working on you to make you stay in, the simplest solution is to get out and look for something else. Once you can identify how Fear and Greed like to work on you, you’ll be able to come up with straightforward but effective ways to deal with them.
Don’t let your money burn a hole in your pocket
I really hated this saying when I was a kid. Every time my mom or dad paid me for pulling weeds or mowing the lawn, I’d hear it. “Whatever,” I thought as I jumped on my bike to head to over to the store. All I was really thinking about was the comic book or toy or some other doodad that had my name on it – not on trying to hang on to the money I had to work hard to get.
It’s funny to see how those tired old lines we hated so much “back in the day” have application not only in life, but in the investments we make. Letting our money burn a hole in our pockets means that we are all too often ready to throw our hard-earned capital away too quickly. This is a tendency that Fear and Greed feed on voraciously. It’s natural, since we are so often told that the best way to make our money grow is to let it work for us. This mindset creates a false sense of urgency that takes a lot of traders out of the market before they had a chance to figure out what happened.
Let’s suppose that you’ve gotten out of a bad investment; the timing just wasn’t right. You’re smarting a little bit, but at least you got out. That’s a good thing – but then you might need to be ready for Fear and Greed to switch gears and try a different tack. “Hurry,” they’ll say. “You need to get back into something quick, or you’re going to miss out. You’re money isn’t working for you – it’s just sitting there.”
What they really want is for you to jump into the first investment you can find that might, possibly, sort of, look a little bit good. Don’t buy into their logic – it’s absolutely, 100% wrong.
The stock market has been around for nearly 200 years. Over that time, there have been innumerable opportunities come and go. In any given day, it is possible to find a handful of good investment opportunities – and sometimes there are a lot more than that to be had. Missing out on an opportunity isn’t as bad as it seems, because there is always another one down the road. You can bank on it.
Not letting your money burn a hole in your pocket means that you can shrug off the disappointment of missing out on a good investment because you know you’ll be able to find another one soon. This mindset eliminates the lie Fear and Greed want you to accept as truth. It also makes it easier to take opportunities as they come rather than forcing your way into in- vestments that more often than not won’t work out. When you’re looking for investments in the middle of economic trouble like a recession, a global pandemic, or both, this mindset be comes even more valuable and important, since finding good opportunities to buy stocks or time the market requires considerable patience and diligence.
Limit your risk exposure
Yes, that’s right, I’m going to talk about position sizing – again. This is a drum that I keep beating for the simple reason that if you don’t apply it correctly, you’ll leave yourself even more open to all of the emotional battles we’ve bee thinking about for the past two weeks. I’ve learned through my own sad and troubled experience that the best way to manage my emotions in any single trade I take on is to make sure that how much risk that position really exposes me to is as small as possible. That’s why under normal circumstances, I recommend using no more than 7% to 8% of your account’s purchasing power for any one trade, no matter whether you are buying a stock outright or selling a put to start with. If you feel current market conditions make things more risky, consider lowering your maximum position size to no more than 3% to 4%. That will makes it far easier to keep making good investments while keeping the decisions you have to make about existing positions rational and objective.
My most recent put sale on TSN is a good example of what I mean; you can look at my Track Record to see the numbers I’m about to refer to. This is a stock that I’ve followed quite a bit over the last few years, and that I’ve used on a few different occasions for useful income-generating trades. Before the trade that I placed in October of last year, my last trades with this stock were in April 2020, and before that March of 2019. In April I used the stock for a Bull Put Spread, while the March 2019 was a straight put sale. For both of those trades, I sold 2 contracts, putting me on the hook to potentially be assigned 200 shares at $65 and $63, respectively. That is a capital obligation of $12,600 to $13,000 that I had to keep in reserve, either in cash or margin, throughout the duration of the trade.
For the most recent put sale, I decided that I needed to be more conservative. Part of that was driven by uncertainty in the broad market, while I don’t mind admitting that another part was influenced by the reality of holding a number of open positions on other stocks at the time that restricted the total amount of liquidity I had to work with. So I shortened the size of my trade to a single contract, meaning that I could have been assigned the stock at $56.50 – but only 100 shares, which put my capital obligation at $5,650. That’s much more conservative and easier to manage. This week’s put sale on CAG took a little bit different approach, selling 3 contracts for a total potential obligation of $10,950 ($36.50 X 300 shares) versus the 2 contracts I used in trades I placed last year with that stock. With fewer total positions already being held, I was more comfortable with expanding that position just a bit; but since I still want to be conservative and cautious, keeping the potential obligation to less than 5% of my total account size helps keep the trade within manageable limits. That means that Fear and Greed don’t get to play as many games with my head as they might be able to do otherwise.
If you are a new subscriber, please take some time to review the videos in the Getting Started area of the website. These will give you a pretty comprehensive view of the value-oriented approach I use to generate income with put selling and covered calls. You will also find it useful to read my Frequently Asked Questions article. Also feel free to review my previous posts as you’ll find additional answers to many of the questions you may have.