The 3 Fatal Flaws to avoid in 2009

2008 will be a year to forget for most investors I know. With the major market indexes plunging by 40% or more, many investors lost their shirt. I saw a story on the news today recognizing the leading money managers of the year and found it interesting that these managers were winning awards even though their performance in 2008 resulted in their clients losing money. I don't know about you, but I don't find much consolation in "not losing as much" as the major market indexes. A loss is still a loss.

The only investors who made money in 2008 were those that used bearish strategies, like shorting stock and any number of option strategies. This year, more than any in my investing lifetime (0ver 20 years) separated the winners and losers based on strategy. If you don't know any bearish strategies or when to apply them, you lost money in 2008.

So the big question I hear most investors asking now is, "is the worst behind us, or is 2009 going to be more of the same?" Given the unprecedented steps taken by governments around the globe, I wouldn't rule out a quick recovery in the market, but I wouldn't bet on it either. If all the money and credit being pumped into the world economy doesn't do the trick, what tools are left to stop the next meltdown? Not many.

So here's what I think every investor needs to look at if they want to survive and prosper in 2009. I call them the three fatal flaws. Time for a little honest self-evaluation.

Fatal Flaw #1 - No Plan.

Most investors simply have no plan. Ask them to describe their trading or investing plan and they may describe a strategy or two they use, but most simply can't provide specifics in such things and portfolio and trade management, risk tolerance, profit objectives and other very important things.

So to start 2009 off right, you need to create a plan, and it should be written. Your plan needs to specifically define your goals, objectives, strategies, tolerance for risk, profit and loss targets and decision making process. The more mechanical you can become in your decisions, the less emotion will influence them. The hardest part of creating your trading plan is to keep it focused. If it takes you several pages to define these things you're likely not focused enough. Keep it simple applies here.

Fatal Flaw #2 - No protection

If you learned one lesson in 2008, I hope it's that you need to have a plan for when things go wrong. The strength of your emotions will make it nearly impossible to make a wise decision in the heat of the battle (when the market is tanking) if you've not clearly defined those things in advance.

The conventional wisdom of the investment community has always said that if you're well diversified, you can ride out anything. If you believe that, chances are you've made nothing over the past decade, even though we've had two incredible bull markets followed by two painful bear markets. I don't believe buy and hold is the answer anymore. I'm not advocating day trading either, but to survive the volatility we've seen over the past decade, you need to be "actively involved" in your investments. A simple stop loss on each new trade is a good start. The low cost of trading makes it easy to get back in if you get stopped out before you wanted to, but if you set a stop loss point with each new trade you place in 2009, you'll eliminate completely the catastrophic losses that most investors experienced in 2008 for the rest of your investing life.

Think about this. If you took the total amount you lost on your worst trade this year and figured out what percentage of your overall returns you could have saved by eliminating that one loss, you'd likely see a simple way to do 1-2-3% better every year going forward by simply eliminating one catastrophic loss. A stop loss can do that.

Fatal Flaw #3 - No strategies

There's many strategies that will profit in virtually any market condition. The problem is that most investors only know the ones that work when the market is going up. If you've never made money on a stock that fell in value, you've got a great lesson to learn. As you start 2009, you'd be wise to expand your strategy base to include a few bearish strategies. Get a book, attend a seminar or webinar, or hire a personal coach to teach you, but please make an investment in education to expand your strategy base.

I'd specifically suggest learning to use options as they offer investors a simple way to play directional moves up or down in the market with limited risk and unlimited potential. You can also use options to hedge your stock positions against the unexpected. They are not as complicated as many make them out to be.

If you are a victim of any of my 3 fatal flaws, now is the time to take action. I tell people that if they don't what they are doing, it's never a good time to invest, but if they know what they are doing, there is always opportunity in the stock market. Now that interest rates are nearly zero, you're going to need to invest if you want to reach your retirement goals. Your goal should be to learn to make money no matter what the market is doing. It's possible.

Best of luck in all your investments.

Ross