The Most Important Skill

You won’t find much argument among investors that the most important skill in trading / investing / gambling is the skill in avoiding over-playing. Several prominent economists and investors have labeled stock picking as easy or random, and one economist’s study even proved that industry professionals have not hardly an edge over just indices, but actually hardly an edge over a portfolio selected by thrown darts. (Link here) I put forth that it’s not stock selection that makes a trader successful, but the avoidance of stock selection. The knowledge, ability and self-control to remain inactive when times are tough or there is a dearth of attractive investments.

Stocks and poker are incredibly aligned. In both, the collection of information is vital to the decision making process. The winners are typically the ones with more information, the elusive “edge,” that allows them to capitalize on alluring opportunities and avoid the ones that aren’t. But, in both, the fail rate is absurdly high; because in both, contestants are constantly drawn to compete, confident that what they decide to do is the right action, even though it may not be. In poker, it’s the players that, even though there may be present some reasons to continue to play, have the ability to throw away cards because the end result isn’t “+EV,” or positive expected value. There definitely exists a corollary to stocks.

The most troubling fault of unsuccessful traders is that they constantly feel the need to participate. They often take on positions that do not present favorable risk vs. reward. Further, they continue to trade themselves into holes they cannot escape from, only securing their failure.

You can play the stock market three ways — You can bet something goes up, you can bet something goes down, or you can not bet at all. Mastery of the first two will make you money, but mastery of the third will keep you alive.

As a sidenote, my friend ChessNWine, a tabbed blogger here on iBC, is the best at this skill; a true master of self-control and risk vs. reward.

http://chivotrades.com @chivotrade facebook.com/chivotrader