Daily Gains Letter

Think Baseball When It Comes to Successful Investing

By for Daily Gains Letter | Jan 4, 2013

DL_George_4My beloved New York Yankees failed to win the World Series, but that’s okay—at least for the time being.

Success in baseball swirls around the abundant statistics, as is the case in trading stocks, but there are major and subtle differences.

In fact, the key to achieving stock market success is more akin to pitching than batting.

Let me explain. In baseball, the ultimate goal for every batter would likely be to hit over .300—that is three hits for every 10 at bat for you baseball neophytes. Of course, there are exceptions for the home run hitters, unless you are like Willie Mays—one of the top five baseball players in history. In trading, stock market success doesn’t equate to winning in only 30% of your trades, which would quickly send you to the sidelines or the poorhouse.

Stock market success is more like pitching. A pitcher who wins 65% of his starts would win about 21 games based on 32 starts. Winning at a 70% win rate would equate to 22 games and a possible Cy Young award (top pitcher) for the mantelpiece. In trading, if your win rate was 65% to 70% and you cut your losses, you would likely achieve stock market success.

The key to stock picking and stock market success is simple—make sure you make more money than you lose. To do this, you need to make sure you cut your losses and, at the same time, ride the winners.

Many inexperienced traders often get caught up in the emotional roller coaster; they take profits on the top stocks, while keeping the poor performers and refusing to admit a mistake was made, which does not bode well for stock market success.

You need to understand that being prudent is important for stock market success, just like it is in baseball. Let’s assume the bases are loaded. The batter, in this situation, doesn’t necessarily try to hit a home run but aims for a hit to drive in runners. This is called playing “small ball.”

The same goes for trading. Aiming for a home run with each trade is fruitless and doesn’t mean stock market success. I would rather play small ball and drive in runs; albeit, hitting that occasional long ball over the fence would be a bonus.

Risk management drives stock market success, just as it does in baseball.

A pitcher would unlikely throw a fastball down the middle of the plate on a 0-2 count—instead, they’d offer up a curve ball, splitter, or change up.

The key is to monitor your pitches and situation, just like trading stocks.

When the price of a stock trends higher, you should think about a potential exit strategy for overall stock market success. This does not mean liquidating profitable trades, but more like protecting your unrealized gains. Take the current stock market rally as an opportunity to take some profits. Trust me, you’ll feel better about it if stocks slide.

Another stock market strategy that needs to be considered is the use of mental or physical stop-loss limits. But, you need to be careful when the volatility increases and wild swings in the stock market materialize that could take you out of your position prematurely.

And, for those of you familiar with options, you can employ put options to help minimize the downside loss in the stock market.

Babe Ruth was arguably the best baseball player in history, while Warren Buffett is widely considered one of the top long-term investors. The key to success in both baseball and trading is to understand the situation, risk, and have an exit strategy.

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