This morning I’m writing to you from the terminal at Denver International Airport as I wait for my flight to Miami. During my wait, a normal, everyday occurrence got me thinking about trading and financial markets, inspiring me to this post.
As I arrived at the gate, there was another flight departing for Orlando. And of course, it was overbooked. The airline had sold nine more tickets than there are seats on the plane. Which means, they were looking for nine (un)lucky people to agree to delay their travel plans until 3pm, when a later flight to the same destination might have room for them. If you or I tried to do business like this, it would be illegal.
Imagine if I was trying to sell my car, and I agreed to sell it to three different people. Then I told them all to pick up the car at the same time. Each buyer would certainly be shocked (and rightly so) to discover that the goods they purchased were also sold to two other people! I’d likely soon receive a not-so-pleasant visit from the cops.
But of course, airlines are allowed to oversell the seats on their flights all the time. And we all just agree to go along with it, despite the potential negative impacts to our most valuable—and nonrenewable—resource: our time.
Normally I would never advocate that you do business like this. Not only is it probably illegal to do in most circumstances, it’s also unethical. However, I couldn’t help but think about the parallels between this practice and trading stocks.
It’s never a good idea to rely on just a single position, or even just a couple of positions, to work out in your favor. The stock market is fickle, and even the best analysis is proven wrong sometimes.
If you only have one or two positions in your portfolio, then you are 100% reliant on only one or two things going right for you. This is a tenuous position at best. If one position goes bad, it can severely hurt your chances of making money overall.
Instead, we want to have many different positions concurrently in our portfolio. Instead of having just 1-2 positions, try to manage a portfolio of 8-12 positions. This makes it so that no single position can have a strongly negative impact on your account. Instead of putting all your eggs in only one or two baskets, you now have a dozen baskets that might bear fruit.
It’s akin to a farmer planting seeds. If a farmer only planted a single seed at a time, he’s taking a huge risk that one plant will take root, survive, and grow enough to be harvested. Instead, a farmer plants many seeds at a time. Even if one or two or a dozen of those plants fail to survive until the harvest, he’s not worried because he has hundreds or thousands of other plants. Having a few die on him is no big deal.
In the same way, you want to have many different positions in your portfolio at the same time. If any one position moves against you, it should be no big deal because at any point in time you’ve got a handful of other positions that are making money; you’re not relying on only one or two positions to work out. Just like the airline that overbooks its flights, you want to “overbook” your profits.
The important question is: “on which side of the transaction are you?” If you’re like most airline passengers, there is no upside to having to delay your flight plans because the airline sold your seat to someone else. It’s a purely negative experience.
But if you’re the airline, it’s just good business. The airline gets to maximize revenue, while the only downside is that it occasionally has to make an embarrassing announcement about overbooking and ask some people to take a different flight. Airlines don’t focus on just one or two customers to bring in the profits. In fact, they regularly have too many customers for a flight.
So be like the airline. Have enough positions in your portfolio that any losers are more than balanced out by your many other winners. Of course, this can only happen if your positions are well-researched, your analysis is solid, and your risk management is on point—all ingredients of a successful trading plan.