Rules-Based Investing Essential for Stock Investors
by Scott O'Neil
The trait most common among successful investors is not intelligence, experience or intuition. It’s discipline.
Disciplined investors actively use a set of proven rules that protect them and guide them through the ups and downs of the stock market. Those ups and downs can stir up costly emotions. Fear and greed (fed by the “noise” of numerous opinions) drive untimely buys and sells. Pride leads us to rationalize losses, and hope makes us hold on to stocks that can demolish a portfolio. Not only do rules prevent disaster, they represent a consistent approach to making profits and taking better control of your portfolio.
In this article
- Stock Selection Rules: Find the Right Ideas for You
- Portfolio Management Rules: Balance Risk, Keep Your Holdings Manageable
- Buy Rules: Enter a Position Correctly
- Sell Rules: Lock in Wins, Avoid Losses
- Overall Market: Make Friends With the Trend
- Rules: Stick to Them
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Control is the opposite of what most investors have felt this past decade. Since 2000, owning stocks, for all of us, has felt like being in the ring for 12 rounds with Mike Tyson. Your stock gets hit with bad news or an analyst downgrade, and then, just when you’re getting up off of the mat, another earnings season is upon you. Meanwhile, that great fundamental story doesn’t seem to be lifting the stock’s price; you’re still down on the position. Worse, you hear a choir of opinions singing the praises of buying on the dips, saying “what a great value XYZ Corp. is at current prices,” so you buy more. Then one morning you log in to check your account, and your equity is down another 15% or 20% on the year. Just try combating the full range of emotions that enter the picture now. Your retirement is at stake, and you still haven’t recouped losses from the 2000 bear market or maybe the 2008 bear market. Your thoughts get understandably bleak. “I can’t get a break … nothing is working.” Unfortunately, many individual investors are in these shoes right now.
The good news is that every bear market ends at some point, usually when investors least expect it. We all know that stocks outperform all other asset classes over the long haul. But when we are so battered and bruised from this decade, how do we stay optimistic? We do it by standing firm with our investment rules, because we know they will see us through in the end. Incorporating rules isn’t necessarily about being smarter, it’s about being more disciplined. When “X” happens, I do “Y.” It’s that simple. Even better, rules are accessible to all. No matter your investing style or experience level, the investing legend you admire—whether it’s Lynch, Graham, or Buffett—has a set of rules that you can study and apply to your portfolio.
One of the biggest challenges investors face today is the overwhelming amount of investing advice that gets thrown their way. My investment team and I thus have a rule to limit the sources of information we use. Too many outside sources can create confusion, particularly if you listen to the mainstream business media’s constant stream of spot analysis and conflicting recommendations on specific stocks. Buying based on another investor’s recommendation, without knowing why that stock is a good idea or how it fits in your portfolio, is an approach that seldom works. Picking stocks based on a gut feeling, without doing your own research, is another recipe for failure.
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