Every investment must pass the "Sleep Test".
An investment should not be so large that you lie awake at night worrying about it. To be a
successful speculator or investor you must be able to remain relaxed and objective. An uncomfortably large
investment or trade, although offering a potentially great return, can jeopardise your ability to
remain objective and can thus lead to mistakes.
2. Avoid the emotions of hope, greed and fear.
Hope is often associated with unrealistic expectations and causes an investor to cling to a losing
position, magnifying the losses unnecessarily. Greed causes an investor to buy at the wrong time,
such as near the peak of a rally, and to risk excessive amounts of money. Fear prevents an
investor from buying at a time when the market presents the best opportunities to buy and prompts
him/her to sell at the worst possible time (at the bottom of a correction or bear market).
3. A corollary to Rule 2 is: Treat your investing/trading as a business, not a Vegas-style gamble.
a) Checking your emotions at the door. You won't be
able to make objective decisions if you get excited by profits and/or
depressed by losses.
b) Following an entry and exit plan for every stock you buy.
c) Not caring what happens to the price of a stock
after you sell it. If you constantly worry that a stock will rocket
higher after you sell then you will never be able to exit at an
d) Ignoring the cheerleaders. The cheerleaders --
those commentators who become progressively more bullish the higher the
price goes and who focus exclusively on the potential for huge rewards
as if buying into the market right now were a sure path to great riches
-- tend to bring out the gambling spirit in their followers.
4. Use a disciplined risk-management approach at all times.
It is difficult to admit to a mistake. There is also usually the fear that if I sell now for a small loss the
price will immediately rebound and I will have lost the opportunity to profit from the rise. After all,
"hope springs eternal" and that stock that keeps dropping like a stone will one day soar like an
eagle; all I need to do is be patient.
5. Minimise the role of luck in your investing by playing a percentage game.
A systematic approach to risk management, which may or may not include
'stop losses', must be used to protect your investment capital. This is
a hard lesson to learn and can usually only be learnt the hard way
Playing a percentage game encompasses the following guidelines:
a) Do not try to make a killing during
any given year, but, instead, follow an approach designed to
generate above-average returns over several years. In this way you
might actually end up making a killing, but be aware that the vast
majority of people who set out to get rich quick in the stock market
end up a lot poorer.
b) Never plan to buy at the bottom or sell at the top. Instead, plan
to buy on those occasions when the reward/risk ratio is high and to not
buy, or to sell, on those occasions when it is low.
c) Take some money off the table during periods of extreme
strength so you won't feel pressured to sell during the periodic
Do your buying during those times when the fundamentals AND the price action are favourable.
d) Do some buying during the severe shakeouts that periodically occur in long-term bull markets. Note, though, that
this will usually only be possible from a financial and/or an emotional
standpoint if you previously took some profits into strength
e) Never make whole-scale buy or sell decisions. Instead, scale into
positions during weakness and scale out during strength, all the while
maintaining exposure to the long-term bull market of the time.
f) Don't 'bet the farm' on any single forecast. Forecasts, regardless
of how well thought-out they appear to be, are just opinions, and any
opinion can be wrong.
g) Don't risk a large portion of your capital on any single stock.
Regardless of how attractive a stock appears to be, acknowledge the
fact that 'stuff' sometimes happens even to the best of companies.
fundamentals are favourable if the current price of the stock is low
relative to the value of the underlying business, where the value of
the underlying business is detemined by the company's assets and growth
Examples of favourable price action include consolidations or basing patterns within longer-term upward trends.
Don't focus on the profit/loss of a trade while the trade is on-going.
Thinking about how much money you are making or losing on a trade while
the trade is on-going may cause the emotions of fear and/or greed to
influence your decisions. Have an exit plan for each stock and continue
to monitor the fundamentals and the price action to determine whether
to hold or to sell.
8. Make sure your exit plan for a stock is consistent with your entry plan.
example, if favourable price action was your main reason for
buying a stock then you should exit if the price action turns
unfavourable. In this case a reasonable approach could involve setting
a protective stop just below a technical support level. However, if
your decision to buy was based primarily on value considerations then
it would make no sense to sell simply because the price became lower.
9. Remember that there are no absolute highs or lows.
It is often the cheapest stocks that fall the furthest and the most expensive stocks that show the
greatest price appreciation. Also, a price level that seems low or high today might appear the
opposite in 12 months time.
10. Always maintain a substantial cash balance.
You must always be in a position to take advantage of any opportunities that arise and the only
way to do this is to always have significant cash reserves.
11. Close an event-based trade as soon as the anticipated event occurs.
For example, let's say a company you follow is about to announce its latest earnings. You expect
the company to announce earnings that surprise on the upside and purchase the stock with the
aim of taking a profit in the days following the announcement. If the company subsequently
announces a result that does not exceed expectations you must immediately sell because the
basis for your trade has proven to be false. If, however, the company does announce higher-than-expected
earnings then you must sell within a few days of the announcement irrespective of the price action
because this was your plan going into the trade. A disciplined approach will prevent short-term
trades from becoming unwanted long-term investments.
12. Don't be stingy when it comes to market information and stock buy/sell prices.
The speculative investor does not day-trade and does not enter a
position with the aim of taking a quick small profit. The timeframe for
a trade will generally range from 1 month to 24 months and the goal
will be to achieve an above average return (for example, a return of at
least 30% on a 12 month investment would generally be sought). As such,
it makes no sense to hold out for that last few cents when making a
purchase or a sale.
Market- or stock-related information that increases your chances of investing/trading success is worth paying for.
13. Be aware that when the public is either extremely bullish or extremely bearish, the risk of a trend change is high.
When the vast majority is extremely bullish then everyone who is going
to buy has already bought and there is only one direction for the
market to go, and that's down. Similarly, when the vast majority is
extremely bearish then everyone who is going to sell has already sold
and there is only one direction for the market to go, and that's up.
Beware, though, that what constitutes a bullish or bearish extreme will
differ depending on the long-term trend (sentiment can, for instance,
become more bullish and stay bullish for longer during a bull market
than during a bear market).
On average, you should not realistically expect to find more than two great opportunities per year
to profit from market timing (sometimes there will only be one and there will seldom be more than
three). As such, it pays to be patient and to wait for the major market reversals that usually
accompany extremes in mass psychology. When these opportunities occur, the speculative
investor must be financially prepared (refer to Rule 10) and psychologically prepared (refer to Rule
2) to take full advantage.
15. Remember and learn; don't regret or blame.
Take full responsibility for all of your investment decisions and
never fall into the trap of blaming others when things go wrong. Losses
are often learning experiences and can actually be money well spent if
they prevent you from making the same mistake again, but if your
reaction to a loss is to look outside yourself for someone/something to
blame then you've learnt nothing from the experience and the money was
16. Keep yourself well-grounded.
This encompasses the following:
a) Never complain about losses or brag about profits.
b) When the market is trending strongly higher and your stocks are
going up every day remember that you are nowhere near as smart as you
think you are; and during the severe corrections when every stock you
own appears to be headed towards zero remember that you aren't as dumb
as you feel.
c) Be prepared to change your opinion if the facts change. In other
words, don't become wedded to any stock or to any market view.
d) Don't act as if the current rally will be the last great money making opportunity. It won't be.
e) Always keep your mind open to new ideas and analysis/evidence that
contradicts your current view of the financial world. Most people are
quick to embrace anything that confirms/matches their existing beliefs
and to dismiss anything that contradicts these beliefs, which is why
most people never see the signs of a trend change until it is too late.
17. Know the story behind every stock you buy.
It is not enough to
simply follow the recommendations in any newsletter because even if
these recommendations are on-the-mark you won't be able to buy or to
hold in the amidst of a selling panic unless you have the confidence
that stems from having a thorough understanding of the story.
18. Know yourself.
For example, if you are someone who gets antsy and
has trouble sleeping whenever the stocks you own make big moves, then
don't buy volatile stocks. Or if you know you are going to be too busy
to fully understand the stories behind individual stocks then allocate
most of your stock-market-related capital to mutual funds.
19. Never use margin debt.
NEVER buy stocks on margin unless you are a full-time professional
investor/trader with a long track record of successfully managing risk.
This is because as soon as you begin using margin debt you become a
'weak hand' (you become someone who would likely be forced to sell in
reaction to a sharp price decline, that is, someone who would likely be
forced to sell at a time when they probably should be doing some buying)
20. Don't take it too seriously - have fun !
After all, it's only money.