There seems to be an X-word in every avenue of life.
The Street has its own – the D-word.
It spells D-e-r-i-v-a-t-i-v-e-s.
Whatever reasons there are for a crisis to develop become secondary at the peak of the crisis, because derivatives take over. The crisis is driven to the nth level because of massive institutional leveraging in derivatives in the direction the crisis is unfolding. Recipe for disaster.
The human instinct is to maximize profit, irrespective of any consequences. When masses start shorting the stock of a company that’s already in trouble, its stock price can well go down to zero (and lead to bankruptcy), even if the company’s mistakes are not deserving of such a price / destiny.
Similarly, when masses start going long the futures of a company’s stock, the resulting stock price overshoots fair-value in a major way. Then come along some fools and buy the scrip at an extreme over-valuation. They are the ones that get hammered.
That’s the way this game has unfolded, time and again.
Does it need to be this way for you?
Firstly, as a long-term investor, don’t buy into over-valuation. Make this a thumb rule. Control your animal instinct that wants a piece of the action. Leave the action to the traders. You need to buy into under-valuation. Period.
Unfortunately, most long-term investors (myself included) miss action. Then they fool around with their long-term holdings to get some, and in the process mess up their big game.
The animal instinct in the long-term investor can be channelized and thus harnessed. One way to get action is to play the D-game. Of course with rules. The benefit can be huge. Action focuses elsewhere and doesn’t mess up your big game.
So, play the D-game if you wish, but play it small.
Secondly, be aware that you’re only doing this to take care of the action-instinct. Any profits are a bonus.
Thirdly, keep the D-game cordoned off from long-term investment strategies. No mixing, even on a sub-conscious level.
Then, take stop-losses. DO NOT ignore them.
Also, when anything is disturbing you, DO NOT play the D-game. It DOES NOT matter if you are out of the D-game for months. Remember, this is your small game. What matters is your big game.
Categorically DO NOT listen to tips.
If you are down a pre-defined level within a month, press STOP for the rest of the month.
Make your own rules for yourself. To give you some kind of a guide-line, I’ve listed some of mine above.
A D-game played with proper rules can even yield bombastic profits. 95% lose the D-game. 5% win. Derivatives are a zero-sum play-out. 5% of all players cash in on the losings of the other 95%.
So, play in a manner that you belong to the winning 5%.