EC Rules For Stock Speculation

Here are 21 rules/guidelines that I try to follow when speculating in the stock market. I don’t always follow them and in such cases I usually end up regretting it.

1. Every investment must pass the “Sleep Test”

An investment should not be so large that you lie awake at night worrying about it. To be a successful speculator or investor you must be able to remain relaxed and objective. An uncomfortably large investment or trade, although offering a potentially great return, can jeopardise your ability to remain objective and can thus lead to mistakes.

2. Avoid the emotions of hope, greed and fear

Hope is often associated with unrealistic expectations and causes an investor to cling to a losing position, magnifying the losses unnecessarily. Greed causes an investor to buy at the wrong time, such as near the peak of a rally, and to risk excessive amounts of money. Fear prevents an investor from buying at a time when the market presents the best opportunities to buy and prompts him to sell at the worst possible time (at the bottom of a correction or bear market).

3. A corollary to Rule 2 is: Treat your investing/trading as a business, not a Vegas-style gamble

This involves:

a) Checking your emotions at the door. You won’t be able to make objective decisions if you get excited by profits and/or depressed by losses.

b) Following an entry and exit plan for every stock you buy.

c) Not caring what happens to the price of a stock after you sell it. If you constantly worry that a stock will rocket higher after you sell then you will never be able to exit at an appropriate time.

d) Ignoring the cheerleaders. The cheerleaders (those commentators who become progressively more bullish the higher the price goes and who focus exclusively on the potential for huge rewards as if buying into the market right now were a sure path to great riches) tend to bring out the gambling spirit in their followers.

4. Use a disciplined risk-management approach at all times

It is difficult to own-up to a mistake. There is also usually the fear that if I sell now for a small loss the price will immediately rebound and I will have lost the opportunity to profit from the rise. After all, “hope springs eternal” and that stock that keeps dropping like a stone will one day soar like an eagle; all I need to do is be patient.

A systematic approach to risk management, which may or may not include ‘stop losses’, must be used to protect your investment capital. This is a hard lesson to learn and can usually only be learnt the hard way through experience.

5. Minimise the role of luck in your investing by playing a percentage game

Playing a percentage game encompasses the following guidelines:

a) Do not try to make a killing during any given year, but, instead, follow an approach designed to generate above-average returns over several years. In this way you might actually end up making a killing, but be aware that the vast majority of people who set out to get rich quick in the stock market end up a lot poorer.

b) Never plan to buy at the bottom or sell at the top. Instead, plan to buy on those occasions when the reward/risk ratio is high and to not buy, or to sell, on those occasions when it is low.