As one decade comes to a close and a new one begins, now is the time to review what you did in the past and think about strategies you can adopt in 2010 and beyond to help you build your wealth through share trading.

What would have worked in 2009?

Looking back on 2009, it seems there were a few easy ways to make money. I wonder if you were smart enough or lucky enough to take advantage of what we all agree was a pretty extraordinary year.

Here’s one strategy that would have worked…

All you had to do was buy an exchange traded fund like STW or VAS in March or April of 2009, then hold on to it until the end of the year. You would have made a healthy 30%.

A basket of blue chips would have delivered the same result.

So what stopped you from doing it?

Running with the pack

You might think that no-one back then could have been sure the market had bottomed. But actually there were plenty of signs that shares were cheap, which I pointed out back in April 2009 in my article ‘Shares are looking cheap!’

If you hesitated about jumping in when others were selling, you’re not alone. It turns out that most investors follow the crowd, buying when others buy, selling when others sell - and losing money in the process.

Behavioural economics

The field of behavioural economics has some fascinating insights into why we invest the way we do, as well as some potential lessons on how to do better. Here’s what it has to tell us.

Overconfidence

It turns out that the herd instinct is one of the most powerful forces driving investor behaviour. Essentially, it seems we would rather be wrong in company than right alone.

That’s the reason for Warren Buffett’s famous advice:

‘Be fearful when others are greedy and greedy when others are fearful.’

But simply taking a contrarian stance isn’t enough.

The evidence is that most of us are unjustifiably confident in our superior good judgment. For example, in one US survey, 82% of people said they were in the top 30% of safe drivers - unlikely, to be sure. And overconfidence is as likely to lead contrarians astray as anyone else.

Loss aversion - when fear trumps greed

Having made a bad call, we’re also unlikely to change it. It’s a thing psychologists call ‘loss aversion’, and it’s what stops us from selling bad investments long after it’s clear that our capital would be better used elsewhere. It’s also one of the reasons people don’t snap up shares in a weak market - they’re more afraid of making a loss more than eager to make a profit. Fear trumps greed, in other words.

All of these psychological quirks can lead us to make bad investment decisions.

So what can you do about it?

When a plan comes together

The key is to create a formal trading plan, then consult it every time you trade.

It doesn’t have to be complicated. One easy solution is to have a checklist of fundamental ratios with a target range to measure stocks against.

The indicators you choose will depend on your investment style. I’m a big fan of the PEG ratio, which compares a company’s P/E to its forecast growth. That helps you decide whether a higher P/E is justified. Return on equity (ROE) is also a powerful measure of exactly what sort of return a company is making on its shareholders’ funds.

You’ll want to add others of your own. And if you’re interested in technical analysis, you might want to create a charting strategy too.

The only resolution you need to make

Make sure your strategy includes sell signals as well as buy signals. And while your plan should evolve with market conditions, it’s important to stick with it - no matter how uncomfortable that sometimes makes you feel.

So make that your new year’s resolution: to create a strategy and stick to it. And have a great year on the markets in 2010!

    Posted in Stock market from Investor on 2. Feb. 2010