10 Essential Skills for Mastering the Tradecraft of Investing

Master investors are a rare breed. They consistently outperform the market without taking high risks. Anyone with an average I.Q. can learn these 10 essential skills. You probably have some of them already.

Here are 10 essential skills an investor must have, or must acquire, if they want to become a Master Investor. I'll go through them one at a time.

Those who have acquired even half of these essential skills will undoubtedly see significant improvement in their investment performance. Those who master all 10 skills will likely go on to become Master Investors.

1. Self-awareness

According to Psychology Today, self-awareness involves taking a close look at our thoughts, beliefs, and emotions. It is important, because it’s a major contributor to personal development.

Self-awareness requires self-reflection, which is difficult for many of us to do. We tend to avoid too much self-reflection because it can be uncomfortable to admit our flaws. But this is exactly why self-reflection is a critical step towards self-awareness. 

Recognizing our shortcomings allows us to take steps to improve our decision-making. This helps us to avoid falling into the same old patterns of thinking and acting that are holding us back from getting to a higher level of competence.

A great resource for learning how to acquire this skill is Daniel Kahneman's book Thinking, Fast and Slow. I consider this book essential reading for anyone who is serious about improving their investing skills.

A case study in self-awareness.

Early in my career as an equity trader, I was tasked with recruiting and training new talent for our trading desk. I had a trainee who was smart as a whip and eager to make a name for himself. But he had a serious flaw when it came to self-awareness. 

He believed that he could beat the market by sheer force of will, regardless of how weak his assumptions and reasoning might be. He didn't do his homework, thinking that his intelligence and enthusiasm would be all he needed to succeed. That was a serious failure of self-awareness.

This young man thought he was smarter than other traders and the market itself, but he was wrong. He made trading decisions by the seat of his pants. In the trading world, we call this type of trader a gunslinger, and most gunslingers end up dead.

Because he resisted the idea of doing serious self-examination into what his shortcomings were, he washed out after just 2 months on the trading desk.

He went into sales after that, and he did very well at it. In the sales realm, persuasiveness and confidence are skills that get rewarded. But they don't work in the stock market.

2. Situational awareness

After you get over the hurdle of self-awareness, your next challenge is mastering the art of situational awareness. Self awareness involves looking inward, but situational awareness requires looking outward and observing what's going on in the market and the economy.

Where investors get tripped up is by coming to the table with a predetermined belief system that has worked for them in other aspects of life but don't work in the realm of investing. Situational awareness requires open-mindedness.

A great question to ask yourself when assessing an opportunity is "What would have to happen in order for my investment thesis to be proven correct?" If you answer this question honestly, it can reveal possible flaws in your assumptions. 

3. The ability to think critically

Critical thinking is a skill that can be learned by anyone who is willing to do a little work. The basic idea is to set aside your prior beliefs and assumptions about a subject and slow down your thought process. By doing this you will have a more realistic picture of what you're looking at.

There's no magic formula, but there is a set of steps you can take to help you think critically. These are the steps in critical thinking.

4. Measuring and managing risk

Measuring risk is very different from managing it. Measuring risk is a technical process where you gather data from relevant sources and come up with a score - maybe a scale of 1-10. Risk scores will change over time, so you must be aware of the state of the current investment environment.

Managing risk means proactively adjusting the overall riskiness of your portfolio as conditions on the ground change.  Against the Gods by Peter Bernstein is a great place to start.

5. Understanding Portfolio Theory

If you're not familiar with the concepts of Portfolio Theory and Game Theory, you're going to have to do some reading. Below is a short list of very good books on the subject.

In short, Portfolio Theory presents a hierarchy of decisions, beginning with asset classes and then drilling down to increasing levels of detail before finally getting to specific security selection. Many investors mistakenly assume that security selection is the most critical part of their decision process, but it's actually the least critical step when it comes to designing a portfolio. 

6. A well-calibrated B.S. Detector

This skill relies heavily on your critical thinking skills to filter out the torrent of B.S. that streams over the internet and inundates your mailbox. Much of this bad information is easy to detect, but scam artists are becoming more clever every year.  

Penny Stock newsletters, Day Trading seminars, Elliott Wave trading systems, Pirates, Charlatans, and Flim-Flam artists are all part of the landscape investors must navigate. What they all have in common is a too-good-to-be-true track record. 

When you come across one of these operators, ask them whether their track record is based on backtesting or published recommendations that can be tracked and verified. There are some good resources for this. TipRanks is one example, and Hulbert Interactive is another. 

7. Familiarity with market history

Stocks For The Long Run by Jeremy Siegel is a great place to start if you don't have a solid knowledge of market history. Against the Gods by Peter Bernstein is another great choice. Without a sense of history, it's impossible to put the current market environment in context. The market never repeats the past exactly, but lessons from the past will inform and guide you as you navigate the present.

8. Selectivity about where you get your information

S&P Global, Refinitiv, Morningstar, StockRover, Barron's, Bloomberg, Portfolio Visualizer, FinViz, ETFTrends, Investing.com. These are all solid information sources that you can use in your due diligence process.

9. Ability to design and execute a plan

Your Plan is everything. A well-written plan includes your investment policy, trading rules, checklists, pre- and post-mortem trade evaluation, and maintenance routine. Your plan does not need to be complex and detailed in order to be useful. Some of the best plans I've seen are no more than two or three pages long.

It's a good idea to keep your plan as simple as possible, at least for the first draft. A plan is a "living document" that you will review frequently and make adjustments based on what's working and what's not.

One important part of your plan is the contingency section, which is where you lay out, as specifically as possible, what defensive steps you will take when the next bear market comes along. Even self-described buy & hold types need a contingency plan, if only to lay down some rules for bargain hunting during bear markets.  

10. Awareness of cognitive and behavioral biases

Overconfidence, Hubris, Myopic Loss Aversion, Get-Even-Itis, Recency bias, Sunk-cost fallacy, etc. These are a few of the biases most investors struggle with. And that includes Master investors like Buffett, Soros and Lynch. 

As part of your self-awareness skill set, knowing your tendencies to fall into these bias traps will help you avoid costly mistakes. It took me several years to finally realize that I was selling my winners too soon and holding on to my losers for too long (the disposition effect). Once I figured that out, my performance improved significantly. 

Final thoughts

This is a lot to take in, but don't worry. You don't have to master every skill on this list to become a Master investor. The best way to approach this is by starting with self-awareness and then working your way down the list. 

You will find that most of the other skills will automatically improve as you continue to work on your self-awareness. When I went through this list, I sat down with a pen and a legal pad and listed all of the cognitive and emotional biases from The Little Book of Behavioral Investing by James Montier. Then I did some serious soul-searching.

I admit that this was an uncomfortable process, but what I gained from it was invaluable. I recommend that you at least give it a try.