Every investor is different. And every investor is influenced by his or her biases and personal experiences. It doesn’t matter if that investor is a professional money manager like me, or a dabbler who plays with a couple hundred dollars in an online trading account.
But no matter how you trade, or how you first learned about the markets, you’ll inevitably develop your own thoughts about how the markets work.
Sometimes, those biases allow you to observe something that most other investors don’t, and turn a handsome profit. But much more often, they steer you in the wrong direction, and prevent you from making money.
|Emotion has no place in a successful trading strategy.|
The Pitfalls of False Consensus Effect
Many investors, including extremely experienced ones, have a tendency to believe other investors think as they do. For example, I might assume a weak economic report will have a negative effect on stocks, and make trades based on that assumption. My reasoning may be sound, but more often than not, this strategy will backfire.
Why? Because of the False Consensus Effect. What I might think is logical causation (e.g. weak economic data = declining stocks) may not seem so logical to other investors. So it’s just as likely that assets will move in the opposite direction.
One reason it’s so difficult to predict market movements is because they’re based on complex information sets. Our minds can never hope to process all the data points that combine to determine whether a given asset goes up or down, and by how much.
At the same time, humans have a natural tendency to think they can crack that secret code. We believe our thought processes are rational, and other like-minded investors will see the same data the same way we do. This False Consensus Effect is one of the most common investing mistakes, committed by even some of the most seasoned investors.
How I Counteract False Consensus Effect
During more than 25 years as a money manager, I’ve learned not to rely on my own experiences or biases to make investment decisions. Like most other investors, my crystal ball is only about as accurate as a long-term weather forecast — in other words, not very accurate at all.
This is not false modesty. I’m just telling you something you need to know if you’re going to become a successful investor: No one can predict the future. Any investment professional who tells you he has the answer is either lying or delusional.
Countless fortunes have been lost and dreams dashed by employing a strategy of investing by prognostication. The fact is that it is impossible to predict with any certainty or reliability how investors will react to any bit of news or data.
But there is a way to invest with a reasonable expectation of consistent success: Trend Following.
Trend followers wait for trends to develop and be confirmed. Then, and only then, they jump in. If the trend fails, they exit and wait for the next one. It may not offer the adrenaline rush that many investors seem to want these days, but it’s a method that has worked for many years, and will continue to work in the future.
As you may have guessed by now, I use a systematic trend following strategy that I developed with my friend and mentor, the legendary investor Sir John Templeton. The objective trading model we created doesn’t try to forecast the future. It simply identifies trends and takes positions accordingly. If the trend fails, the model will exit. If it continues, I stay the course.
During the twelve years I managed the mutual fund founded by Sir John, I learned to invest differently from the crowd. I learned to use not just my smarts and common sense, but Wisdom as well. (That’s what Sir John named his mutual fund, and for good reason.)
Sir John was such a successful investor because he possessed innate wisdom and calmness, which gave him the ability to see things others could not. This sounds simple, but I can assure you it is extremely uncommon.
The trading model we developed seeks to harness that wisdom, and see trends developing from extremely overbought or oversold conditions — trends that other investors cannot yet see.
Over the course of his investment career, Sir John relied on one motto:
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest of fortitude and pays the greatest ultimate reward.”
That is what trend following is all about — finding the trend change at the top or bottom of the market, and investing with it.
I’ve found that the only way to do that consistently is by using a carefully designed systematic trend following strategy. By strictly following the model Sir John and I developed, I have learned how to make unemotional buy and sell decisions, and how to put my clients and subscribers in the right markets at the right times. Remember: Emotion has no place in a successful trading strategy.