IBD article hw3;Q&A With William O'Neil Follow A System Rather Than Your Emotions
Date: 7/27/98
Jesse Livermore, a famous old trader who made and lost millions in the stock market, once said: ''There are only two emotions in the market - hope and fear. The problem is, you hope when you should fear, and you fear when you should hope.''
In this, the third part of our 26-week series on successful investing, Bill O'Neil talks about how to keep emotions out of investment decisions.
Q:
What did Livermore mean by ''hoping'' when you should ''fear'' and vice versa?
O'Neil:
When a stock falls in price below your cost and you're losing money, you hope it'll go back up. But you really should be fearing that you might lose more money. And you should react by selling the stock and cutting the loss.
When a stock goes up in price and you're making money, you fear you might lose your profit. So you sell too soon. But the fact that the stock is going up is actually a sign of strength.
Q:
Isn't that against human nature?
O'Neil:
Whenever your own money is on the line, it's going to be emotional, and the stock market is no exception. But the market doesn't know who you are personally. And frankly, it doesn't care what you think or what you would like to see happen.
Human nature is deeply embedded in the market, and the same emotions of ego, gullibility, fear and greed that existed 50 years ago continue today.
Q:
How do you overcome these natural, yet potentially costly, emotional reactions?
O'Neil:
In my experience, the only way is to establish buying and selling rules derived from historical research -rules based on how the market actually works, not on preconceived personal opinions and beliefs.
Lawyers analyze history and use precedents, so why shouldn't you? The more you know about the past, the more you'll know about the future.
Q:
How is the past helpful in the case of the stock market?
O'Neil:
We've built models, or profiles, of every outstanding stock each year beginning in 1953. Rather than listening to personal opinions, hot tips and rumors, most of which are faulty, I know exactly what the characteristics of the biggest winners of the past were - a recipe for successful stocks, of sorts. This helps guide me as I seek tomorrow's new leaders.
Analyzing history also provides perspective on the market as a whole. Daily and weekly market fluctuations intimidate even the most experienced investors. But a look at the past will show that there's an overall uptrend in the market, cycle after cycle, that creates a huge ongoing opportunity for investors.
Q:
So knowing the facts and examining history are the keys?
O'Neil:
They're important. But so are developing sound habits and sticking to rules. And that's the harder part. It can be even more difficult for individuals who have followed unhealthy habits for years and years. Changing these is a real challenge and takes considerable effort.
Q:
What are some of the worst habits investors have?
O'Neil:
One is the almost addiction-like attraction to low-priced stocks. The idea of buying a large block of a $2, $5 or $10 stock and watching it double sounds wonderful. The only problem: Your odds of winning the lottery are better.
The fact is, investing in stocks is not the same thing as buying a dress or a car on sale. The market is an auction marketplace: Stocks sell for what they're worth. And when you buy cheap stocks, you get what you pay for.
Of the best-performing stocks of the last 45 years, the average per-share price before they went on to double or triple or more was $28 a share. That is fact.
Q:
So, should that be the minimum?
O'Neil:
I do not buy stocks under $15 a share. Of my few really big winners over the years, I started buying two of them at $16 a share and five at $50 to $100 a share.
Sound scary? Don't laugh: The $100 stock went to the equivalent of $550 a share. The best companies that are leaders in their field simply do not come at $5 or $10.
Many people want to get rich overnight, which simply does not happen. Success takes time and a willingness to objectively and honestly analyze your past mistakes in the market.
Q:
Admitting mistakes isn't easy.
O'Neil:
No one likes being wrong. But letting your ego get in the way of proper analysis of a prior action, or falling in love with a stock and failing to look at it objectively, are not sound when it comes to the market.
An invaluable tool I've found is to do a post-analysis of all my trades. Every six to 12 months, I jot down the point on a daily chart where I bought and sold every stock, as well as the reasons I bought or sold each one.
Then I separate those I made money on from those where I lost money. What was I doing right on the stocks that went up? What mistakes did I make with the others?
Then I make rules that will help me avoid the same mistakes in the future. I also keep the charts to continue analyzing my trading behavior.
Next week, O'Neil will discuss the benefits of using both fundamental and technical analysis in selecting stocks. |
