As an individual investor that looks to invest in stocks, you are better off learning from the most successful traders of all time than from the legends of the mutual fund world. Studies show that the average investor in stocks does a considerable amount of trading, and the turnover of their brokerage accounts is not indicative of a buy and hold approach. Furthermore, the average investor holds less than 10 stocks. So if this describes your approach, why are you listening to portfolio managers that have average holding periods of 3 years or more, and hold over one hundred stocks?

Being a successful long term investor depends on having superior knowledge than the crowd and excellent judgment in putting all the facts together. The fact is most of us mere mortals and prone to making errors in judgment. But the good news is that you don’t have to be a long term investor in order to succeed. In fact, you have a huge advantage over conventional mutual funds if you are a trader with an arsenal of the appropriate weapons.

You can make a lot more as a swing/position trader with average holding periods of 2 weeks- 3months, if you know what you are doing. Many of these successful traders are people you have never heard of and for good reason—they don’t offer any of their services to the public. Many of them trade for themselves, trade for proprietary desks at banks, or trade for hedge funds that you haven’t heard of. Some of them are old school legends – like Jesse Livermore, Gerald Loeb, William O’Neill, Michael Steinhart, George Soros – that are familiar to many. These traders all made returns over 30% annually with large sums of money, and some of the lesser known traders have averaged in excess of 60% over long time periods with a high degree of consistency. The interesting fact is that while these traders had vastly different styles, they all shared the same common traits that were obviously critical to their success.

1. Focus on Loss Control: Even though the judgment of each of these traders could be considered excellent, ALL of them were very quick to admit that they were wrong on a position and exited rapidly with minimal loss. They never rode losing investments down to the bottom while hoping for the market to let them off the hook. They also planned their exit points in advance and only risked an amount capital that they could afford to lose. This is what prevented them from going bust while sometimes using extreme amounts of leverage. In contrast some of the major trading disaster stories like Long Term Capital Management, Barings Bank, and most recently Amaranth were situations in which the key traders were unwilling to give in to the market and took positions and leverage in a size that did not permit any margin for error. If they were wrong they would be bankrupt, and that is exactly what happened.

2. Concentrated Positions: To make such extraordinary returns, these traders would focus on 5-10 positions at maximum in order to allocate their money to their very best ideas. This concept only works in conjunction with quick and tight loss control. Therefore, the lack of diversification is more than made up for by superior loss control. This way if you take a 10% or 20% position, if you are right and a stock goes up 100% you make 10% or 20% on your entire portfolio, if you are wrong and cut losses at 10%, you lose 1%-2% of your portfolio. So you can afford to be wrong 9 times and still make money if you last investment doubles. Therefore, it is not about being right 70% or even 50% of the time. All these traders focused on making far more when they were right then when they were wrong. They would never let one Nortel or JDS Uniphase ruin their portfolio. All of these traders would be out quickly, and busy looking for the next investment.

3. Active Rebalancing: To really make the system work even better, these traders would quickly reallocate capital to either the positions that they own that were performing the best, or to new and fresher positions. They would quickly eliminate stocks that fell to their loss limit OR were not moving up over a period of a few weeks. This helps to ensure that you expose yourself to enough opportunities that eventually you will find the investment that goes up 40%-100%. Indeed my own research confirms that active rebalancing enhances returns, which is contrary to the conventional notion that turnover hurts returns. The problem is that most people (and mutual funds) sell their winners and hold their losers, when they should be doing is riding their winners until they slow down and selling their losers quickly.

To many of you this probably sounds opposite to what you would want to do instinctively or to what you might have been told by your broker/investment advisor, or heard through the media. However, remember that the goal of mutual funds, and investment advisors is long-term investing, and using the same rules for trading will kill your performance over the long term.