I'd also recommend reading Nassim Taleb's books Fooled By Randomness and The Black Swan (info at his website http://fooledbyrandomness.com/) along with one he recommends:
SkyMarshall said
Those will all teach you what not to do, which is just as, if not more important in investing and trading than what to do.
Anyone can notice the successful investment decisions after the fact: buying Apple Inc on March 6, 2009 at $83.50 or selling BP on January 19, 2010 at $62.30. No stock or mutual fund can beat the market, each year, over twenty years. Neither can you.
What you can do is not beat yourself. Within the nuts and bolts of a portfolio, some trades may cost you dearly in terms of capital gains tax. Lopsided distribution of your investments in too few asset classes will also wreck havoc. Avoid these mistakes and you can greatly improve your rate of return.
<another_shameless_plug> I run the investment website http://blog.realized-app.com and companion web app for getting these decisions right. </another_shameless_plug>
That highlights a fundamental error many people make - you can't average percentages. A graph of an index fund on a percentage basis for the last 20 years tells you nothing useful (at least not directly).
Here's a key excerpt from What I Learned Losing a Million Dollars, basically the book in a nutshell. Forgive the wall of text, but it's worth the read.
This starts right after the author finishes recounting how he lost his $1.6M fortune and seat on the Chicago Mercantile Exchange back in the mid 80s:
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It was a painful realization to discover that I wasn't a trader. I didn't have the patience or mechanical skills to be a successful floor trader, nor the consistency to be a successful upstairs trader. If I was going to learn how to make money trading, I was going to have to find out how others had done it. I went and read the books and articles about, and interviews with, sucessful market professionals. I studied the best investors and traders from Wall Street and La Salle Street: Peter Lynch, Bernard Baruch, Jim Rogers, Paul Tudor Jones, Richard Dennis and many more. After all, when you're sick you want to consult the best doctors, and when you're in trouble you want the advice of the best lawyers. So, I consulted what the successful pro's had to say about making money in the markets. If I could figure out how they did it, I could still pull off getting rich again. And this time I would keep the money.
Below is some of the advice the pros offered for making money.
Advice and Dissent:
'I haven't met a rich technician.' - Jim Rogers
'I always laugh at people who say, 'I've never met a rich technician.' I love that! It is such an arrogant, nonsensical response. I used fundamentals for nine years and then got rich as a technician.' - Marty Schwartz
'Diversify your investments.' - John Templeton
'Diversification is a hedge for ignorance.' - William O'Neil
'Concentrate your investments.' - Warren Buffet
Averaging a Loss:
'You have to understand the business of a company you have invested in, or you will not know whether to buy more if it goes down.' - Peter Lynch
'Averaging down is an amateur strategy that can produce serious losses.' - William O'Neil
'Don't try to buy at the bottom or sell at the top.' - Bernard Baruch
'Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich.' - Jim Rogers
'I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle. Well, for twelve years I have often missing the meat in the middle, but I have caught a lot of bottoms and tops.' - Paul Tudor Jones
Spreading Up:
'When you're not sure what is going to happen in the market it is wise to protect yourself by going short in something you think is overvalued.' - Roy Neuberger
'Whether I am bullish or bearish, I always try to have both long and short positions - just in case I'm wrong.' - Jim Rogers
'I have tried being long a stock and short a stock in the same industry, but generally found it to be unsuccessful.' - Michael Steinhardt
'Many traders have the idea that when they are in a commodity (or stock), and it starts to decline, they can hedge and protect themselves, that is, short some other commodity (or stock) and make up the loss. There is no greater mistake than this.' - W.D. Gann
I had expected there might be some subtle differences among the pros. After all, some were stock market moguls, while others traded options or futures contracts. But didn't these guys agree on anything? Based on the examples above, they sounded more like members of a debate team trying to score points against each other.
I had to find out how the pros made money in the markets. I had to learn the secret that all of them must know. But if the pros couldn't agree on how to make money, how was I going to learn their secret? And then it began to occur to me: there was no secret. They didn't all do the same thing to make money. What one guy said not to do, another guy said you should do. Why didn't they agree? I mean, here was a group of individuals who had collectively taken billions of dollars out of the markets and kept it. Weren't they all doing at least a few things the same when they made their money? And if the first guy hadn't lost, why didn't the second guy?
If imitating the pros was supposed to make you rich and not imitating them was supposed to make you poor, then each one of these guys should have lost all his money because none of them imitated each other. They all should be flat broke b/c they very often did things opposite of each other. It finally occurred to me that maybe studying losses was more important than searching for some Holy Grail to making money. So I started reading through all the material on the pros again and noted what they had to say about losses.
Losses:
'My basic advice is don't lose money.' - Jim Rogers
'I'm more concerned about controlling the downside. Learn to take the losses. The most important thing in making money is not letting your losses get out of hand.' - Marty Schwartz
'I'm always thinking about losing money as opposed to making money. Don't focus on making money; focus on protecting what you have.' - Paul Tudor Jones
'One investor's two rules of investing:
1. Never lose money.
2. Never forget rule #1.' - Warren Buffet
'The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable. They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and costs them dearly.' - William O'Neil
'Learn how to take losses quickly and cleanly. Don't expect to be right all the time. If you have a mistake, cut your loss as quickly as possible.' - Bernard Baruch
Now I was getting somewhere. Why was I trying to learn the secret to making money when it could be done in so many different ways? I knew something about how to make money, I had made a million dollars in the market. But I didn't know anything about how not to lose. The pros could all make money in contradictory ways because they all knew how to control their losses. While one person's method was making money, another person with an opposite approach would be losing - if the second person was in the market. And that's just it; the second person wouldn't be in the market. He'd be on the sidelines with a nominal loss. The pros consider it their primary responsibility to not lose money.
The moral of course is that just as there is more than one way to deal blackjack, there is more than one way to make money in the markets. Obviously, there is no secret way to make money because because the pros have done it using very different, often contradictory, approaches. Learning how not to lose money is more important than learning how to make money. Unfortunately, the pros didn't explain how to go about acquiring this skill. So I decided to study loss in general, and my losses in particular, to see if I could determine the root causes of losing money in the markets. As I said at the very beginning of this book, I may not be wise, but I am now very smart. I eventually did learn from my mistakes.
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At the beginning of the book he said, "Smart people learn from their mistakes. Wise people learn from others' mistakes". The rest of the book is an examination of the psychological and emotional reasons for the distorting biases, poor judgement, and bad decisions that lead to loss and failure, as well as a strategy for avoiding that.
I agree - The Black Swan is great. It's a great read with an interesting viewpoint on the Finance world and investment strategies that are sometimes contrary to what the so-called experts say.
Can I be the contrarian here and suggest that both _Fooled By Randomness_ and _The Black Swan_ are overrated, overlong books consisting largely of impenetrably written anecdotes and roman-a-clefs shellacked onto a few basic, true, valuable ideas about the failings of human psychology?
What do either of these books teach you about trading, other than "never forget that shit happens, because your mind will do everything it can to convince that it won't?"
That's one way of looking at it. Some assert that Taleb's work is a tautology, as you seem to, while others, especially in academia, have been trying to disprove/discredit/find flaw in it. I won't try to argue that, but will just point out a few things, in no particular order:
- FBR and TBS are both for lay audiences. Taleb has hashed out his ideas in numerous academic papers posted on http://SSRN.com as well.
- In investing and trading, knowing what not to do is often easier and more valuable than knowing what to do. All three books I referenced are all about that, though Taleb's are more on a philosophical level than What I Learned.
- You get more out of Taleb's books if you also read the stuff he references in his bibliographies, from What I Learned..., to Mandelbrot's (Mis)behavior of Markets (understanding Black Swans in terms of fractal randomness gives it a whole new meaning), to Taleb's first book on trading Dynamic Hedging (where he basically explains his extremely technical trading strategy to hedge and exploit the shit that happens in markets), to the stuff on SSRN.
- Most books on trading (or any other kind of advice these days) can be said to overdevelop a single topic or idea. Partly to pad pages, but also partly to drive home the message to the lowest common denominator of their audience. If you're the type that can speed read through the whole thing in a few hours, try not to hold that against them if the content is good.
- If his ideas are relatively simple, why does the whole world keep fucking them up? Both the financial crisis and the BP oil spill can be examined from Taleb's framework. Why have governments not realized how fundamental these ideas are and 'robustified' society against 'shit happening'? (these are all rhetorical questions, I know the answers) Someone needs to keep driving them home till we all grok that robustness + redundancy > optimization in many areas.
- Nobody in academia, government, or media took him seriously for a long time, even with a Wharton MBA and 99th percentile track record in trading. He said he had to get a PhD to help get his message across. That his ideas may now seem obvious is probably a 'hindsight is 20/20' thing.
The world fucks up his simple ideas because the whole nature of his simple ideas is that the human brain is riddled with biases that cause it to misinterpret raw information. Essentially, his core idea is just that misunderstanding risk is human nature.
I'd also recommend reading Nassim Taleb's books Fooled By Randomness and The Black Swan (info at his website http://fooledbyrandomness.com/) along with one he recommends:
What I Learned Losing a Million Dollars
http://infraredpress.com/
Those will all teach you what not to do, which is just as, if not more important in investing and trading than what to do.