Olson's Observations

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If there is one thing I have learned about investing it is that, to be successful in the long run, you have to be disciplined.  Discipline can come in many forms but in this post I have one form that I want to focus in on.  I want to focus on setting price targets.  Firm price targets.

Price targets help to take the emotion out of investing.  You should set a reasonable upper bound that is above your purchase price and a reasonable lower bound that is below your purchase price (key word, reasonable) when you first invest in a company and then stick to those numbers.  By “stick to those numbers” I simply mean you should sell the stock if the stock hits either one of them (yes, even if it hits the lower bound and you’ve lost money – of course, if you think the stock is still solid you could buy more and dollar cost average down but that is another post entirely).

Sticking to these targets will help you avoid large losses and avoid getting too greedy when you have already made a healthy profit.

The issue that any investor faces when they are not disciplined is the natural human reaction to “chase a loss”. An example of chasing a loss is as follows. Say you have a stock and it currently sits at $50 per share (the selling point/target in this example) and you decide to hold it even though $50 was one of your targets.  The stock then drops to $46.  Instead of selling at $46 you will say you’ll sell when it hits $50 again.  The stock then drops to $40 and you rethink your current target of $50 and suggest that you’ll sell the stock if it gets back to $46 and so on and so forth until you have chased the loss all the way down.

If you had set one of your bounds at $50 ahead of time and have stayed with it you wouldn’t have ridden the stock as low as the person did in the above example.  I am sure some people will say, “yeah, but what if the stock went back up, you would have lost that extra value.” Those people would be exactly right but the issue is that you can never truly time the market.  You never know when the upper bound or lower bound will hit and if you think you can time the market you end up chasing losses.

All of the great investors I have watched since my youth and some who I have also had the pleasure of working for are always very disciplined in their approach and while this means they don’t hit every peak or valley and thus don’t extract or lose the maximum amount of value it does mean that they consistently see solid returns.

Creating discipline through price targets is one way to keep yourself from allowing emotion into the investing process. Too much emotion in the investing process typically doesn’t lead to good returns.