Posts filed under “Rules”

Trading vs Investing (and Today’s Bounce)

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Let’s not mince words: Yesterday’s market action – down 1.75% on heavier volume — was a shellacking:

DJIA 12715.93 -213.66 -1.65%
Nasdaq 2991.22 -55.86 -1.83%
S&P 500 1358.59 -23.61 -1.71%

We are now rather oversold, and are due for a bounce. What I want to look at is the quality of the market internals during this period. It will provide some insight into how far we could bounce back, and where support might be if and when this reaction rally (2-7 days) fails.

I find whenever I discuss these sorts of technical actions, people get confused by the apparently conflicting perspectives (“You sound bearish today and bullish yesterday“). The key to understanding these are your holding periods and timelines. The wiggles in the day-to-day action mean different things to traders, investors, and company insiders.

My holding period is typically measured in quarters and years. But I feel compelled to be aware of what takes place over weeks and months. Shorter time periods than that — hours and days — are so noisy as to be meaningless to me.

Sometimes it appears market participants are disagreeing when they are really just looking at different holding periods.

Investors should never try to “play the squiggles” — using long term valuation measures to trade in and out for a quick profit rarely works. I’ve seen many a good investment turned into a trade — dumped on initial strength shortly after establishing the position for the quick winner, only to watch it run away over the next year. Its usually accompanied by this hackneyed phrase: “No one ever went broke taking a profit.”

Actually, they do. You need big winners to offset a lot of little losers, and small winners don’t help. Its like snatching defeat from the jaws of victory.

Traders who allow a short term position to turn into an investment are usually doing so because they got caught leaning the wrong way and are refusing to admit their error. Rather than take a small hit, they nurture their losing position on the hopes of it recovering. That happens rarely, but far more often the bad trade turns into a giant loss. In some cases, it becomes a blow out disaster that ends the trader’s career.

Any trader that wants to let a winning trade can and should do so, but they must establish a new exit rule for that position. I never like to give back more than 25% of a gain in these circumstances. You can alternatively use a shorter moving average as your exit signal.

My rules:

1. Make sure you understand what your holding period is before you establish any position.

2. Traders should NEVER let any losing trade turn into an investment.

3. Strong investments should be given the benefit of the doubt, rather than taking the quick profit.

4. Winning trades should be allowed to run, but require a new exit strategy.

These are fairly basic but oft overlooked ideas. Understand them or create your own, but please don’t just wing it. That’s a real formula for disaster.



Expect to Be Wrong in the Stock Market (The

Category: Apprenticed Investor, Investing, Markets, Rules, Technical Analysis, Trading

5 Things That Surprised Me About A Career on Wall Street

I had a conversation with a friend recently about Wall Street. We discussed some of the odder aspects of the Street, not so much about investing itself, but about having a career in finance. I have a somewhat skewed and skeptical perspective on Wall Street. I started out as a lawyer (I loved law school…Read More

Category: Apprenticed Investor, Rules

Jesse Livermore’s Trading Rules (1940)

From Jesse Livermore comes these Reminiscences of a Stock Operator: With New Commentary and Insights on the Life and Times of Jesse Livermore   1. Nothing new ever occurs in the business of speculating or investing in securities and commodities. 2. Money cannot consistently be made trading every day or every week during the year. 3….Read More

Category: Rules, Trading

5 Signs You’ve Matured as a Trader

Joe Fahmy has guided his hedge fund to outperformance over the past 13 quarters. He has been sharing his trading skills to a novice to intermediate traders based on his 16 years of trading. This is our their attempt at creating bite size, easy to understand, bullet points for traders. The prior posts are here…Read More

Category: Apprenticed Investor, Rules, Trading

Jeremy Grantham: 10 Lessons

Nice list from Jeremy Grantham, via Marketwatch: 1. Believe in history “All bubbles break; all investment frenzies pass. The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.” 2….Read More

Category: Apprenticed Investor, Investing, Psychology, Rules

5 Qualities of All Great Traders

I met Joe Fahmy a few years ago at Lindzenpalooza. He has a great way of communicating his trading skills to a novice to intermediate traders based on his 16 years of trading. Fahmy has guided his hedge fund to outperformance over the past 13 quarters. As previously mentioned, I wanted to present something less…Read More

Category: Apprenticed Investor, Rules, Trading

David Merkel: The Eight Rules of My Investing

David J. Merkel is a CFA, FSA. His forthcoming equity asset management shop is tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities.where he researched a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. From 2003-2007, he was a leading commentator at the investment website

These are his Eight Rules of Investing:


My objective in guiding investors is to teach them how to tilt the odds of success in their favor. As a value investor that rotates sectors, I have eight methods that each tilt the odds a little in my favor. Individually, each tilt is worth a little. As a group, they have been very powerful for my past results. Unaudited, these methods have allowed me to beat the market since the strategy started in September of 2000.

  1. Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.
  2. Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.
  3. Stick with higher quality companies for a given industry.
  4. Purchase companies appropriately sized to serve their market niches.
  5. Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.
  6. Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.
  7. Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.
  8. Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.

Each of these rules enforces a discipline on the overall portfolio that most professionals and individual investors do not possess. It takes the emotion out of investing, and forces us to think like risk-sensitive, profit-seeking businessmen. I agree with Buffett when he said, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.” The two disciplines mutually reinforce each other, leading to better results.


Part II is after the jump

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Category: Apprenticed Investor, Investing, Rules

Ed Easterling’s 12 Rules of Market Cycles

Ed Easterling of Crestmont Research boils down his views on long term markets to 12 rules of secular stock market cycles. In case you are unfamiliar with Ed’s work, several books, including Unexpected Returns: Understanding Secular Stock Market Cycles; he also wrote Probable Outcomes. Here are Ed Easterling’s 12 Rules of Market Cycles: 1. Secular cycles…Read More

Category: Cycles, Earnings, Investing, Markets, Psychology, Rules

UPDATED: Trading Rules, Aphorisms & Books

Last month, we put together a full run of Trading Rules & Aphorisms.  In the intervening weeks, I discovered I overlooked quite a few lists that are on the site.

Here is the updated version:

Livermores Seven Trading Lessons

Bob Farrell’s 10 Rules for Investing

James Montier’s Seven Immutable Laws of Investing

John Murphy’s Ten Laws of Technical Trading

Six Rules of Michael Steinhardt

Art Huprich’s Market Truisms and Axioms


Lessons from Merrill Lynch

Rosie’s Rules to Remember

In Defense of the “Old Always” (Montier)

Lessons Learned from 37 Years of Futures Trading

Richard Russell’s The Power of Compounding

My (Ritholtz) own rules

Rules for Shorting

15 Inviolable Rules for Dealing with Wall Street

10 Psychological, Valuation, Adapative Investing Rules

The Zen of Trading

After this run, I plan on updating this list every quarter . . .

Books after the jump

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Category: Investing, Rules, Trading

Art Huprich’s Market Truisms and Axioms

Raymond James’ P. Arthur Huprich published a terrific list of rules at year’s end. Other than commandment #1, they are in no particular order: • Commandment #1: “Thou Shall Not Trade Against the Trend.” • Portfolios heavy with underperforming stocks rarely outperform the stock market! • There is nothing new on Wall Street. There can’t…Read More

Category: Apprenticed Investor, Investing, Rules, Trading