The Feel-Good Investment Strategy You May Later Regret

How do you rate your self-control?

Is temptation easy to resist, or are you constantly battling with yourself?

Now, this can be a hard one to master…all too often people fall victim to their impulses. It’s little wonder many rate a lack of self-control as their greatest weakness.

But getting this right can change everything.

You see, self-control is vital to success. It gives you a hold over your actions. This can help you make good choices, despite a powerful urge to do otherwise.

Don’t worry if your reserves are a little low. Self-control is something you can develop and strengthen. I’ll tell you more about this a bit later.

One of most interesting things I do as a share trader is to read. I’m always looking for insights into what makes the human mind tick. This helps me with the mental side of trading.

An article caught my eye this week. It was a psychological study involving two unlikely subjects — kids and marshmallows. The research has a fascinating parallel with trading.

Let me tell you about it…

The experiment dates back to the 1960s. It was done at a preschool in the grounds of Stanford University. The aim was to test the development of self-control in kids.

So how do you test a kid’s willpower?

Well, with a soft and gooey marshmallow, of course.

And that’s exactly what the researchers did.

Each child was put alone in a room with the sugary treat. They had one instruction — resist temptation for 15 minutes. If they did, they’d receive a second marshmallow as a reward.

You can probably have a fair guess at the outcome.

A few kids ate the marshmallow immediately. Others desperately tried to hold the line. They put their hands over their eyes, they pulled at their hair, and some even patted the lolly like a pet.

For most, though, it was all to no avail. Close to 70% gave in to temptation.

But that’s not where this ends.

The lead researcher — Walter Mischel — has been following this group ever since. His findings reveal a lot about the importance of self-control.

You see, Mischel found that the longer a child could resist the marshmallow, the better their prospects in later life — academically, financially, socially, physically and emotionally.

Just think about that for a moment. Success is largely due to resisting impulses. It’s about delaying gratification now, for a potentially bigger reward later.

And this makes sense. Self-control affects things like what you eat, how much you spend, and how hard you work. But what does it have to do with trading?

Well, quite a bit actually…

Which trader are you?

Last week I gave you a snapshot of four investment strategies. You saw their strike rates (the percentage of trades they got right) and their profitability.

Here’s a summary of the key data…

Strategy A Strategy B Strategy C Strategy D
Strike rate 88.3% 72.1% 60.8% 60.1%
Profit $53,269 $69,991 $85,271 $109,300

You’ll remember these figures are from back-testing. My aim was to test two exit methods: taking profits and letting winners runs.

Strategy A was to sell a winning trade when it was ahead by 5%. Strategy B would wait for a 20% gain. Strategy C would sell for a 100% profit, while Strategy D would let profits run.

Now, this is where the marshmallow experiment and trading come together.

You see, the A and B strategies give in to the temptation of an early profit. This is just like the kids who quickly ate their marshmallow. The urge to act now overwhelms them.

But, like the marshmallow test, acting early doesn’t give the best overall outcome.

Sure, it may feel good to bank a quick profit. But doing this caps a trade’s upside. You shut down the possibility of a bigger future reward…and this is exactly how many people trade.

Strategy D is the only one to hold out. Profits are let run until a stock hits its trailing stop. This type of trader resists the urge to sell early, and makes the largest profit.

The key to Strategy D’s success is delaying gratification — that’s what makes the 100%-plus profits possible. It’s why self-control is such a big deal when trading.

Resisting temptation

Let me show you a real life example. This is a trade from my own portfolio…

Click to enlarge

You’re looking at the chart for Webjet [ASX:WEB]. I bought in at $4.45 on 1 October 2015. The stock was in an uptrend, and had just hit a 26-month high.

This trade got off to a flying start. My shares were up by 29% within 10 weeks. If I was the type of trader to take a quick 5% or 20% profit, I’d already be at the bank.

But here’s the thing.

I know resisting temptation can give better outcomes. That means I had to turn my back on a fast return. That’s the only way I can make a much bigger profit.

Here’s what happened next…

Click to enlarge

The shares are now worth double my entry price. It’s the adult equivalent of getting that second marshmallow. And it all comes down to delaying gratification.

There’s no guarantee every stock you resist selling will double. Some trades will deliver smaller profits, and others will fail — WEB almost hit my exit stop at a fairly early stage.

But there’s no doubt in my mind: Controlling your urge to sell can make a big difference. It could literally transform your portfolio.

So how do you develop self-control?

Well, I’ll tell you what I do…I practice. For instance, I’ll resist checking an incoming text message when I’m driving, and I’ll turn my back on the fridge when I’m not hungry.

These are just little things. But it gets me in the habit of taking control. This strengthens my willpower and makes it easier to resist bigger temptations — like selling a stock too soon.

Another way to develop self-control is to follow a system. You see, a system is a set of rules, and these can help sway you from impulsive actions.

Despite what many people think, trading isn’t just about buying and selling. You also need to consider the mental side — this is the swing factor that can set you apart from others.

Until next week,

Publisher’s Note: Let’s face it…emotions can be a trader’s worst enemy. It doesn’t matter if you’re an experienced trader or if you’re just starting, you need to keep your emotions in check.

Don’t worry if your emotions are getting the better of you. There are things you can do. I suggest checking out Jason McIntosh’s Quant Trader service. It’ll help you stay in winning trades longer…dump losers faster…and manage risk like the pros.

And right now, you can get instant access to Quant Trader with a 30-day money back guarantee.

Try it. See if it makes sense to you. It could change the way you trade forever.

PS: Quant Trader sources all images above.

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