11 Investment Rules That I Live By

Blogging at A Young Investor, Tony draws from his investment experience in stocks, commodities, and currencies to show others how to invest profitably in today’s volatile markets.

I’m a firm believer in rules – follow your rules, and you can’t stray too far off the path to success. Never is this more true than when it comes to investing – a firm set of good rules will prevent you from buying into a bubble and selling into a crash.

1. When quantifying risk, make sure you give that number some leeway because unexpected, extreme situations tend to happen far more often than straightforward statistical probabilities would assume. E.g. If the risk of investment XYZ is 25%, round it to 30%. This is a prime example of why a lot of investors fail – they take historical data to quantify risk, but reality is, the future is often a lot more extreme than the past so historical data isn’t very accurate when it comes to predicting the future.
2. Investment models are built by adding several investment indicators. If you assign different weights to the individual indicators, there will inevitably be an unjustified bias among them. If the indicator is good enough to be used, it should be weighed equally with the others. As a result, you will be forced to take extra precaution when selecting indicators to use which will make your investment model more sound.
3. Just because a model fits perfectly in the past doesn’t mean it’ll fit perfectly into the future. Computer trading has made the market 10x more volatile than it was in the past when there were no computers.
4. Don’t doubt your model too frequently! When a new and unexpected situation happens, don’t instantly incorporate that new situation into your model because it may be a random outlying event. But if the same “unexpected” scenario plays out a few times, it’s likely that you’ve missed something in your model.
5. Buying on retracements is deadly; you’ll probably miss the investment and buy at a higher price.
6. Good models can’t be bought. If the model creator knew that his model was any good, he wouldn’t be selling it!
7. Creating a good model is hard. You can’t rely too much on long term data because what has happened in the past has changed with the rise of computer trading and quants. On the other hand, you cannot only rely on recent market data because there isn’t enough of an accurate sample.
8. Proper money management (risk management) is more important than developing an investment model. Ultimately, you can delegate everything to an investment model – it’s up to you to decide how much your going to buy/sell a position, how much risk you’re going to take, etc.
9. Learning what to do is easier than doing it. Because successful investing means deviating from standard human behaviour, most people lose and few win.
10. It doesn’t matter how many times you’re wrong, as long as your gains more than make up for your losses. Let your profits run and cut losses.
11. If you’re going to diversify, make sure your investments are uncorrelated. Many investors who “diversified” prior to the 2008-2009 crash found out that their “diversified” assets were all highly correlated – when one asset fell, all the other assets fell. This is difficult because nowadays, most markets move in the same direction.

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