I have been following The Big picture the blog run by Barry Ritholtz from the last 4 years and observed that each year he update his top trading rules and aphorisms. It’s a collection from his favorite trader, analyst, economist and investor viewpoints on what — and what not — to do when it comes to investing in the capital markets.
Here are the rules that he posted this year :
1. Cut your losers short, and let your winners run.
2. Avoid predictions and forecasts
3. Understand crowd behavior.
4. Think like a contrarian.
5. Asset allocation is crucial.
6. Decide if you are an active or passive investor.
- Cut your losers short, and let your winners run. : Perhaps the best investing advice ever, its sophistication is belied by its apparent simplicity.Letting your winners run generates all sorts of desirable outcomes: It allows compounding to occur, gives you the benefit of time and keeps your transaction costs, fees and taxes low. Since this rule does not allow you to take a quick profit for no reason (other than having one), it also forces you to develop an actual exit strategy.
- Avoid predictions and forecasts : Humans are very bad at guessing what the future will bring. The academic literature overwhelmingly proves this. If you prefer anecdotal evidence, recall how many economists forecast the Great Recession (almost none), the initial reviews of the iPad (mostly panned) or even the iPhone (meh!)
- Understand crowd behavior: The investor who understands the behavior of crowds has an enormous advantage over one who doesn’t. He understands that investing often involves figuring out where the crowd is going, even if it’s objectively ”wrong.” Recall Keynes’s theoretical beauty contest, where players were not trying to pick who they thought was prettiest, but rather, select who they anticipated the crowd might pick.
- Think like a contrarian: The crowd can be fickle, overly emotional or even irrational. The contrarian learns to recognize when the crowd turns into an unruly mob. When that happens, it’s time to stop betting with the group, and take the other side of the trade — betting against the crowd.
- Asset allocation is crucial: What is your relative weighting of stocks, bonds, real estate and commodities? In the popular finance media, this gets little attention. Yet all of the academic studies show that it’s the most important decision an investor makes. It’s far more important than stock selection, yet that’s all anyone seems to want to talk about.
- Are you an active or passive investor:For the equity portion of your allocation, you must answer a crucial question: Do you buy indexes and garner market-level returns, or do you pick stocks (or sectors) and time the market in an attempt to beat the indices?
- Those who try to beat the market have a tough road ahead: Each year, 80 percent of professional managers fail to beat their benchmark. Of the few who do, once you take fees and costs into consideration, less than 2 percent actually hit that bogey.If you want to beat the market, understand the long odds that are working against you. That is why for most investors, indexing is a much better bet.