-documented 1st July 1997
Every investor needs to develop a philosophy, a set of rules or principles, that can form the basis for action and review. Over the years we have found whenever we have made an error of substance we have blisfully ignored our own rules and exposed ourselves to loss (or limited our profits) which could have easily been avoided. Our rules may not suit your experience, your approach to the market, your psyche etc etc. But hopefully our rules will help to make you think and encourage you to develop your own rules. Our rules are a combination of our own thinking, The Zurich Axioms of Max Gunther , and the thoughts of John Templeton.
1. It is unlikely that God’s plan for the universe includes making you rich. Success in the stockmarket requires effort, discipline and patience. 90% of success is having the discipline to be consistent.
2. "Research" is to contemplate the possibility that, intuitively, you may not know the answers, and worse still, you may not even know the questions. Information insightfully interpreted will help avoid being caught in a position where you can lose a lot for reasons not understood. Try to avoid making the facts fit the theory, especially in relation to timing. Speculation is not investment.
Buffetology: Can we understand the business? Does it have a sustainable competitive advantage? Do we like the people? Are we getting it at the right price?
3. Trust falling interest rates to begin a new bull market. Bull markets are driven by liquidity. It takes a lot of bad news to reverse a bull market, and a lot of good news to reverse a bear market. Calculate and analyse ‘trend’ very carefully.
4. Long range plans engender the dangerous belief that the future is under control. Try to stay flexible, open minded and sceptical. Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. In a bull market focus on price & momentum, a bear market focus on valuation. Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria. BUY when others are despondently selling. SELL when others are greedily buying. When too many people are doing the same thing the market will adjust. Bull markets are driven by liquidity.
5. Markets over-react slowly; resist the temptation to buy ‘falling knives’. Momentum is essentially the market behaviour of the participants. There is a lot of ‘motion’ in ’emotion’. Do not underestimate the tendency of a trend to ultimately reach a level, either up or down, that is illogical and just plain wrong, and hence, unsustainable.
6. Focus on value and strength. Cut losses, let profits run. Good profits are generally made on new highs. When a market is making a new high it is telling you something. Buy stocks that are coming out of broad bases and are beginning to make new highs. Price going back into a base is bearish.
7. In the long run the stock market indices fluctuate around the upward trend in earnings per share. Calculate see thru earnings for the portfolio.
8. Human behaviour cannot be predicted. Distrust anyone who claims to know the future. Chaos is not dangerous until it begins to look orderly. Beware the historian’s trap, beware the chartist’s illusion.
9. Resist the allure of diversification. Try to get 60% of the portfolio in 12 stocks.
10. Try to find the ‘big story’ every now and again – a recovery, an out of favour cyclical, a takeover, a change in management, a new product, an industry or company undergoing fundamental transformation, a tax change, interest rates.