How a little plastic gnome can help you become a better investor

Trading too often is one of the most common causes of losses in investing. Try invoking a little plastic gnome to put your investments in perspective before making an impulsive trade.

Plastic gnome investingI’ve consistently preached that one of the biggest problems afflicting individual investors is the urge to trade too often. Buying and selling stocks too quickly can lead to extravagant profits, but it can also lead to extravagant losses. I first started trading stocks at the one of the worst times possible: the fall of 2008.

I was moving in and out of banking stocks just as congress was debating enormous stimulus packages. I’d be up 20 percent one day and down 30 percent the next. Some of the companies I invested in (National City, for instance, which was purchased from the jaws of insolvency by PNC Financial Services) don’t even exist anymore. Others have since shot up more than 400 percent from my initial buy price. I didn’t see any of the gains, though, since I got a margin call that nearly wiped out my trading account.

I was buying and holding at the wrong times and day-trading on heavy margin in one of the most volatile markets in decades. But, in many ways, I’m glad I lost gobs of money in the market. It taught me a lot of important lessons. Chief among them? No one can see the future, but in retrospect everything looks clear as day.

Ford Motor Company (NYSE:F), for instance, was trading around $1.50 a share early in 2009. If you would have laid down $15,000 on the company then, your investment would be worth more than $120,000 now – a mere two years later!

When you’ve lost enormous sums of money on a stock, it makes it even harder to want to stick to a buy-and-hold investing strategy. But it really does change the way you approach investing decisions. You stop focusing on the day-to-day news that plagues public companies and you start looking at more important factors: good management, great advisory boards, competitive advantages and long-term growth factors.

Buying for the long run almost requires a re-wiring in your brain. I was reminded of this in a strange source: an article on “Conquering Self-Doubt” in the Wall Street Journal. Apparently, a new form of cognitive-behavioral therapy has emerged in psychological and self-help circles. Dubbed, Acceptance and Commitment Therapy, the field urges acceptance of irrational fears.

“Part of what mindfulness does is get to you to recognize that these critical thoughts are really stories you have created about yourself,” Zindel V. Segal, a professor of psychiatry at the University of Toronto, tells the Wall Street Journal. “They are not necessarily true, but they can have self-fulfilling consequences.”

Applied to investing, an Acceptance Therapist might tell you that rather than watching a stock tick up and down every few minutes and painting horror stories about the losses you might endure, you recognize and accept short-term fluctuations in price and stay with the stock you’ve picked.

“You don’t have to react to (negative thoughts) at all,” Katherine Muller, associate director of the Center for Integrative Psychotherapy in Allentown, Pa., says in the article. “Just allowing them to exist takes away their power.”

Muller goes on to note that she sometimes pulls out a little plastic gnome to embody negative thoughts. Rather than trying to fight the gnome or change his behavior, you just let him sit there with that silly grin on his face, and figure out whether your fears are truly justified. If your fears aren’t justified, just let your investment ride. You’ll probably be glad you did.

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