Everything I ever needed to know about the beach I learned from an old lifeguard named Jimmy Silvano.
Tanned and beginning to gray, he was the first real “guru” I ever met.
A teacher by trade, Jimmy had spent over 25 years watching the world go by from the top of his lifeguard chair. Intuitive as ever, he always seemed to know exactly what was coming next.
When he said the surf would clean up and be monstrous by the end of the day, everybody went home and grabbed their boards. And when he said there was going to be a thunderstorm in about an hour, people scrambled to leave the beach — even in the middle of a warm, sunny day.
When I asked him how he did it, his answer was always the same: “Steve,” he said “you can learn a lot by just watching.”
Not exactly Tao, but close enough for me… And in many ways, I’ve spent more time “just watching” ever since.
But today, the beach is not where I earn my keep. Today, I’m more focused on the equity markets.
That being said, here’s what I’ve learned in over 25 years of watching the bulls and the bears battle it out — and some lessons, I’m sorry to say, were learned the hard way.
Stock Market Investment Advice: 15 Rules of the Road*
*In no particular order
1. All Stocks Can Be Risky
This one should be obvious, and if you haven’t learned it by, now the odds are that you never will. The simple truth is that every time you purchase a stock, it can and will go down. It doesn’t matter whether it’s Apple Inc. (NYSE: AAPL) or BP p.l.c. (NYSE: BP), every new investment carries with it the risk of downside. How you manage those risks is the key to game. It all boils down to risk/reward.
2. Understand Your Risk of Ruin
As every gambler knows, the risk of ruin refers to the possibility that a string of losses will wipe them out entirely. That, of course, is completely unacceptable, since those chips are their ticket to the game. It’s no really different on Wall Street… And that means you need to protect your principal. After all, it’s your ticket to the game. Defend it at all times.
3. Diversify Your Risks
Big bets can make you — but don’t let them break you. Instead, it’s better to spread your risk across several different stocks; that will allow you to avoid the big draw downs that can easily come from losing one large bet on a single company.
4. Always Ease Into New Positions
Successful long-term investors understand the value of dollar cost averaging. This approach spreads out those stock purchases, lessening the risk that you will buy them at “the wrong time.” That way, you arrive at an average price that more often than not better reflects the true value of those shares.
5. Build Your Core Positions Around Dividend Stocks
Even in bear markets, dividend-paying stocks typically do well — especially if those companies have a strong history of increasing the dividend payout. This allows you to build wealth over time as long as you pick companies with a minimal risk of a dividend cut; these stocks create your “safety-net” in volatile markets.
6. Always Reinvest Your Dividends
When an investor receives dividends, they have two choices: The first is to take the cash and spend it; the second is to immediately take those funds and purchase more stock. The smart investor chooses the latter. Dividend reinvestment programs are an automatic way to build wealth.
7. Remember the Rule of 72
Compounding is one of the powerful forces known to man — and it’s where the Rule of 72 comes in. The Rule of 72 maintains that to find the number of years it takes for to you double your money at a given rate, you just divide the interest rate into 72.
For example, if you want to know how long it will take you to turn $12,857 into $25,714 at 9%, you would divide 72 by 9 and get 8 years. But what if you actually saved $12,857 a year at 9% interest for a period of 24 years? How much would you have then? The answer is about $1,076,154 — not bad, huh? Smart investors know that it’s the tortoise that wins this race — not the hare.
8. Be Content to Take a Single
Sure, homeruns are exiting… but a string of singles is just as good. Building true wealth takes time, but it’s completely achievable. For instance, did you know that a 25-year-old could turn a $3,000 a year investment into $1 million dollars in 40 years with only a 10% average annual return? Anyone can — and the smart ones do. Never over-reach.
9. Have a Plan and Act On it
This is the one that is easier said than done. But the truth is that when a position goes awry, it is always best to have stop-loss plan in place; this keeps losses from becoming even bigger. After all, it’s not about being right — it’s about making money.
10. Become a Technician
This maybe a heresy to fundamental investors, but it’s true: You ignore technical analysis at your own peril. Because while P/Es and book values definitely have their place, technical analysis is equally important to volume, price action, and chart patterns. After all, markets — just like people — repeat themselves.
11. Recognize Support and Resistance
Never chase stocks, no matter how tempting they may be… Instead, wait until the market falls back to a known level of price support before you buy. Spotting these levels is often the difference between a winning and a losing trade. Remember, no stock ever goes straight up.
12. Keep Your Eye on the VIX
The “fear gauge” tells you whether or not the markets have reached an extreme bullish of bearish position. If so, that tends to be a sure sign that the markets are about to stage reversal. As usual, “the crowd” hardly ever gets its right. (So much for the rational market theory… ) So the smart money simply uses the VIX indicator as a sign to bet against them all.
13. Buy When the Markets Correct
Warren Buffett said it best: “Be greedy when others are fearful.” But for some reason, retail investors just seem to hate sales. So they buy high and sell low — not exactly a winning strategy. Market corrections may be scary, but that’s the time when stocks have fallen into the bargain bin.
14. Nothing Lasts Forever
As bad as it may seem at times, today’s bear market will eventually run its course. After all, every bull market begins when all seems lost… Conversely, bear markets typically begin at the height of the party, and the smart money knows the difference.
15. Ignore the News
Warren Buffett doesn’t bother watching CNBC, so why should you? The financial news, after all, isn’t any different than your own 6 o’clock news. Drama may draw viewers, but it’s nothing more than a distraction to long-term holders. Smart investors ignore the shrieks of financial press.
16. There’s Always a Bull Market Somewhere
Even in bear markets, there’s always something to buy. If it isn’t in stocks, it’s in bonds, commodities, or even real estate. Smart investors are flexible and follow the trends.
As for the next bull market, I think the biotech sector will lead the way over the course of the next ten years. A troubled economy aside, this is one sector where the right disruptive discovery could earn you a small fortune.
Next week, we’ll a look at why the markets aren’t so rational after all, detailing the eleven emotional hurdles that could be killing your portfolio.
Your bargain-hunting analyst,
Editor, Wealth Daily