Trading stocks or bonds is a big, complicated, murky business, and it's human nature to try to make some sort of sense out of it. Some of the expressions you hear regarding investing are basic good advice, but many are misguided, or conflict with each other.
One of the things I noticed when I worked on Wall Street was that for many adages having to do with trading, there’s an equal and opposite expression. A lot of people will recite these cliches as if they’re giving you the wisdom of the ages, but once you’ve heard
enough of them, you realize that many tend to contradict each other. And
while there’s a little bit of truth to each of them, many are correct about fifty percent of the time.
When I worked
there, my boss would say, “Cut your losses and let your gains run.” On other
occasions he would say, “Bulls make money, bears make money, and pigs get
slaughtered.” (In other words, don’t get too greedy.) But those expressions are
diametrically opposed to each other.
You'll hear that "Wall Street is just a big machine for transferring money from the impatient to the patient." But you'll also hear, "It never hurts to go to the bank,” and "No harm in ringing the cash register," both of which contradict the first one.
Another expression you hear a lot is, “Be greedy when
everyone else is fearful, and fearful when everyone else is greedy.” That's basically sound advice. The problem there is figuring out when the
"fear" and "greed" have run their course. Up or down a thousand points on the Dow? How about four thousand? Bear in mind that this expression
applies much more to overall market swoons and peaks than it does to
individual stocks, which can go up tenfold, or to
zero (unlike the market, at least in the short term).
Another thing you’ll hear is, don’t use leverage (margin) and become overextended. That’s true: there’s no quicker way to go bankrupt (or to get rich). Think of it this way: the difference -- in terms of both peace of mind and lifestyle -- between your current net worth and zero is far greater than the
difference between your current worth and double that.
Another thing you’ll hear a lot is John Maynard
Keynes' famous quote, “The market can stay irrational longer than you can stay
solvent.” That's certainly indisputable: you may have logical, compelling reasons for
why a stock – or the market – should be higher or lower, but that doesn’t mean
that either will revert to reason in the near future. Another reason not to get overextended.
"Markets always tend to swing too widely." This echoes Keynes, and is often true: markets do tend to get overexuberant on the upside, and can reflect too much pessimism on the downside. (But neither necessarily implies an immediate correction.) You'll usually make money by buying the large swoons, but they don’t come all that often. And when they do come, the question is, as always, is this the end of the swoon?
Another truism is to invest in what you
know. The idea there is, if you go into, say, a Costco, and you like the way the
store is organized and you like the prices and you see that they’re getting a
lot of business, you should invest in Costco stock. The only problem with that
is, a lot of other people have already been to Costco, and had the same idea,
and Costco’s shopper-friendliness is almost certainly already factored into its
However, the corollary to that is unquestionably true: don’t invest in what you
don’t understand. (Warren Buffett has always been a big proponent of this.) If someone tells you that such and such a company
has a hot new product, unless you really understand how and where it will be used, and who
the players are, and what competitive advantages each has, it
might be best to stay away. Unless you have complete faith in whoever told you
Another thing you’ll hear is, don’t invest more than
you can afford to lose. That's inarguable. You can drive yourself crazy thinking, wow, with the amount of money I lost on that stock could
have bought a new car! I’m not suggesting you torture yourself this way,
but going through that mental exercise beforehand
is worthwhile. It’s too easy to
start throwing large sums of money around as if it’s a different currency than the one you use in your everyday life.
An investing expression I first heard a few weeks ago is, "All you need to do is find a two inch high bar and then jump back and forth across it." In other words, you're generally going to be better off finding a
little niche and exploiting it than you are by making grand predictions about the course of the overall
I've never known anyone who's consistently right about market direction; I'm not even sure I've ever known anyone who was right more than fifty percent of the time. There are just too many variables. It’s like trying to predict the weather a year from now. No one can
possibly take into account what the Fed, the dollar, the economy, world events,
the stock market, interest rates, commodities, and computerized trading systems will do, and how they will all affect each other.
Yet, some people try. One thing I found on Wall Street is that the surer
someone sounds about market direction, the more full of crap he is in general.
"You're never as good as you think you are, you're never as bad as you think you are." This is another way of saying that luck plays a huge role in investing. With you, and with everyone else. Of course, people tend to use this expression more often when they’re doing poorly. But never underestimate how much luck has to do with outcomes. If picking the right stocks were purely a matter of intelligence, all you’d have to do is hand out IQ tests and follow the lead of whoever scored highest.
"He's talking his book." Often true. Fund managers often appear on TV to talk about how such and such a stock is a fantastic value. When you hear that, bear in mind that he’s merely trying to goose demand to send the price of a stock he owns up (maybe, so he can sell it). Likewise, bank analysts usually talk up a stock if their firm is handling its corporate financing. The “Chinese wall” that supposedly exists between the finance side and sell side of a bank has always been extremely porous.
"It's harder to manipulate the top line than the bottom line." In other words, you can always adjust things like good will, amortization, accounts receivable, set-asides for potential problems, etc., to fudge your profits. But it's much harder to massage the amount of revenues you have coming in. This
is true, and why companies always announce their revenues as well as earnings per share.
Another thing a lot of people look at is insider selling and buying. You always hear that insider selling means less than insider buying because there are always all sorts of reasons for people to sell a stock: because they want to buy a house, get divorced, diversify, etc. But if insiders buy, it’s almost always a good sign. Who else is in a better position to know that their stock is going up? Some investors base their stock trading entirely on following insider buying; that's not a bad strategy.
"Don’t get married to a position." If you own a stock for a certain period of time, it’s easy to fall into the trap of thinking, I’ve held it this long, just think how mad I’ll be if I sell and then it finally goes up. But that’s letting your own emotions – or potential emotions – drive your trading, and that’s never wise.
Those are sayings and bits of advice that have become cliches, some for good reason. Let me add a few things here I've learned on my own. (I'm not suggesting these thoughts are original, merely that they don't come attached to Wall Street cliches.)
As an individual investor, be aware that you're going to be the last person to hear about things that go wrong with a company. And there are an infinite number of things that can go wrong. A competitor could produce a superior product. The company could be sued for something not its fault. There could be production glitches. Any "act of God" -- as the insurance companies phrase it -- could go against them. Legislation, both foreign and domestic, could negatively impact them. Maybe they've been cooking the books. A single rogue employee could singlehandedly bring disaster. You can’t trade as if you’re always expecting disaster, but the possibility is something to be aware of.
Given that you're at an informational disadvantage, also be aware that the stocks of small, early stage companies are even more vulnerable to new information. Unless you have a network of well placed spies, you’ll be the last to hear news which could send a thinly traded stock soaring or collapsing. Given which, you may be better off sticking with huge, liquid, widely traded stocks like GM, XOM, AAPL, and AMZN, which react more to macro trends than to little bits of inside information.
While we're on the subject of inside information, be aware that on the day before an announcement that a company is being bought out, its stock almost always trades up. It’s extremely suspicious, but only rarely does anyone gets prosecuted for insider trading as a result. (It happens, but rarely; my guess is, it’s far less than one percent of insider traders are caught.)
Be leery of taking friends’ advice. I’ve had a lot of friends give me a lot of advice. It was all well meaning, and I’ve never let a piece of bad advice affect a friendship. But just because someone is smart, or witty, or conversant with market terminology doesn’t mean he knows which way a stock is headed. And even if someone has a good track record, in the end, no one is infallible.
Even hedge fund managers aren’t necessarily better than the rest of us. They’re just confident guys with big egos who figured they could outperform the market, were good at convincing others of this, and thus were successful at raising money. Some did outperform the market, and got extremely rich by making bets with other peoples’ money. Others didn't, and simply closed up shop. And even those with good records don't have hot hands which last forever.
If you think that hedge fund managers are brilliant, take a look at their stock picks. It’s surprising how mundane many of them are. They’re usually invested in the most obvious, widely traded, heavily capitalized stocks. When you hear that a certain financial wizard’s largest holdings include Facebook, Apple, Netflix, General Motors, Exxon, Amazon, and Citigroup, it leaves you wondering, where is the genius in that? Most don’t seem to have researchers who tell them which small biotech is going to be the next 20-bagger. This is not to say that such people don’t exist, merely that most fund managers are simply good salesmen.
Some hedge funders have consistently outperformed thanks to insider trading. The Feds were convinced that Steven A. Cohen, who ran one of the biggest funds, was guilty of this, and managed to convict a couple of people who worked at his firm, but were never able to ensnare him. I, of course, don't know, but my guess would be that they were suspicious of him for good reason.
Mentally separate your long term positions from your short term positions. If you buy a stock because you think it can double, don’t then sell because it’s up a point. There’s no harm in day trading a small portion of a large position, to try to capture the daily zigs and zags. But unless the longer term trades start going against you in a big way, sequester them, and continue to think of them as long term. Likewise, if you bought something for a day trade, don’t let it turn into a long term investment.
If you see that a company is run by a guy who comes across like a sociopath, stay away. I’ve ignored that rule in the past, to my detriment. A sociopath is far more likely to be lying about results, or about expectations, or embezzling, or somehow using company funds for his personal use. Or, maybe he just has overly grandiose expectations for what he and his company are capable of, and thus is far more likely to be using leverage and getting overextended (sociopaths like risk). And, he’s likely creating discord within the company, and using bad judgment to drive it into the ground.
Also be aware that while sociopaths constitute only 3% of the overall population, they represent a far larger percentage of CEOs.
Most of us are easily conditioned by the last mistake we made. (And every trade, unless you put all your money in at the very bottom and then take every last cent out at the very top, can be defined as a mistake.) So if you overstayed your welcome in a stock last time, chances are you’ll sell early next time; and if you got out too early last time, you’ll likely hold longer next time. Half of the time that will be the right thing to do, the other half the wrong thing. Just be aware that you’re probably being a little too swayed by your last trade.
Maybe the most important thing is to recognize your own quirks. Are you by instinct a bull, or a bear? Are you a momentum trader, or a contrarian? Do you prefer value stories, or growth stories? You have to recognize your own instinctive tendencies and, if not counteract them, at least, take them into account.
Everybody has personal idiosyncracies in terms of how they invest. And you must be brutally honest with yourself about this. It’s the smartest thing you can do as a trader. The only way you’ll ever learn is by constantly asking yourself, how did I screw up this time?
I’m a contrarian by nature (in case that wasn't apparent from this blog). And one of my weaknesses is that I'm impatient, too quick to take a profit. So what I do more of these days is sell covered calls against stock I own. That way, instead of making one point on a stock if it goes up, I might make two. (And if the stock goes down, I'll be "hedged" by the amount of the option premium.) That limits my upside, but that tends to already be limited by my impatience anyway.
If you're a patient investor, that approach probably isn't right for you. But the point is, I try to be aware of and counteract my personal idiosyncrasies -- and so should you.
Finally, remember what I said at the beginning of this post, that a lot of Wall Street adages are right approximately 50% of the time – and that probably includes much of what I just said.