Why Being “Certain” Is Your Portfolio’s Worst Nightmare

How many of you approach life expecting “certainty?”   How many of you always see all your plans through life work out exactly as you had expected?  Think back to just the past year alone, and ask yourself how well those things you were so “certain” of last year have worked out.

Anyone who has any experience in life knows that life, by definition, is simply uncertain.  I will give you a personal example.  I was lucky enough to marry an incredibly wonderful woman, who also happened to be eight years younger than me.  And, of course, we were looking forward to a long wonderful life together, and I fully, and “reasonably,” expected her to out-live me due to the difference in our ages.  Yet, in an extremely unfortunate turn of circumstances, she contracted a very rare form of cancer when the youngest of our four children was 11 days old, which ultimately took her life. 

Yes, my friends, there is no such thing as certainty in life.  Yet, so many approach financial markets with a perspective of certainty.  My question to you is why would you believe that the financial world is any different than the rest of the world?  Why would you believe you can expect certainty in any part of your life, especially when dealing with your financial nest egg?

What scares me even more so for the average investor is when an “analyst” tells you that something will happen in the market with “certainty.”  They tell you that you must buy a certain stock, or worse yet, a leveraged ETF (which have other major issues associated with them), because the market will “absolutely” do something in the coming year.  Some will even tell you that you should not use stops, and they even provide you with ridiculous reasons for ignoring basic, sound investment advice.  They convince you with promises of huge returns.  And, incredibly, they make these claims with even more certainty as the initial position they suggest goes further and further under water. 

Folks, let’s face it.  Life and the financial markets are uncertain, and one should never approach any market, investment, or trade with any amount of certainty.  To do so is not only foolhardy, but reckless to boot.  Yet, we see too many “advisors” suggesting that certain trades/investments MUST do this or that.  Anytime you are being told something MUST occur, or something will CERTAINLY happen, you are being “sold,” and are not being provided with reasonable, sound investment/trade advice.  These people do not care about your money as much as they care about their own ego.  Sadly, many of them are dangerous to your financial well-being and are no better than con-artists.

Financial markets are non-linear.  That means that there is no certainty in the financial markets, just as in the rest of life.  Therefore, one must approach financial markets from a perspective of probabilities and not certainty.  When appropriately approaching markets from a perspective of probabilities, it means one MUST have certain risk management procedures in place to protect your capital.  And, when managing your own money, you must be focused upon capital preservation, and then you can begin to grow your capital.

Some of the risk management procedures used by experienced traders/investors include using appropriate “stops,” or using hedging strategies.  In fact, I will personally NEVER enter any trade or investment unless I have it planned out well in advance and know before I enter the trade/investment three things:

1 – where do I buy;

2 – what is my target;

3 -  where I stop out if the trade/investment goes in the wrong direction from what I had initially expected.

Moreover, I also suggest that one not put all your “eggs into one basket.”   For that reason, I usually tell investors not to have any position that exceeds 5% of your entire portfolio.

Again, in a life filled with uncertainty, if you apply simple risk management rules, you allow yourself to remain “in the game” for the long term rather than doing what most traders do, and that is blow up their accounts with oversized aggressive “bets.”  And, again, sadly, those “advisors” or “analysts” that suggest otherwise usually leave a trail of blown up investor accounts behind them. 

If you are ever in a position when you see your total account value fluctuating to the downside by more than 10% in a month, it likely means you are not using appropriate risk management procedures.  Moreover, if you have any one (unhedged) position moving to the downside by more than 20% in a month, it also likely means you are not using appropriate risk management procedures.  And, I can assure you that you are likely on your way to joining the many investors/traders who have blown up their account.

In an open letter I send to each and every new member signing up in my Trading Room at Elliottwavetrader.net, I note the following:

“There is an old adage that when you fail to plan, you plan to fail.  So, before you enter any trade, you MUST have a trading plan.  And, most importantly, you MUST adhere to that plan, and not fall into the “hope” that grips most new traders.

The inexperienced traders will sit in a position until it turns in their favor, if it ever does.  Develop a plan BEFORE you enter into a trade, and stick to it.  This is setting you up for what traders view as “cutting your losses short and letting your profits run.”  Remember, it is not “letting your losses run until they finally turn in your favor.”  The money can be better utilized in another opportunity to make money rather than lying dormant or continually losing.

HOPE AND BEING OVERLY AGGRESSIVE BLOW UP MORE TRADING ACCOUNTS THAN ANYTHING ELSE.”

Last week, I showed you an example of an “analyst” that suggested a dangerous “buy and hold” of a leveraged ETF, without using a stop.  (http://news.goldseek.com/GoldSeek/1476972060.php) The position turned against him by over 60% in one month, as he held it the entire time, while promising huge returns to those following him on the trade.  And, does he admit the errors of his ways?  Absolutely not.  He dismisses any such error by ridiculously claiming that “[c]ycle counts aren’t “wrong”. They just are what they are.” Yes, this is nothing less than reckless, and is why he has more postings of blown up accounts from former subscribers over the years than any other analyst I have seen. 

While my own perspective is not so different than this analyst’s about the long term prospects of the market within which he bought the leveraged ETF, there is a right way to go about investing and a wrong way.  Moreover, I recognize I can be wrong, I protect those that follow me accordingly, and would never place anyone in a reckless position based upon any “certainties” or false promises.

One must realize the probabilities that one can be wrong in their initial assessments about the market, and then one must do something about it.  Even if one were to have a 10% stop on a position, you would have been saved over 50% draw-down on this one trade by a simple risk management procedure of using a stop, rather than “hoping” the market will turn up while you continued to lose money.

So, I implore each and every one of you to adopt solid, reasonable risk management procedures to protect your hard earned money, as I can assure you that there are no certainties in life and there are many out there who do not have your best interests at heart.