The Two Best Investment Rules for Volatile Markets

There are two rules that every investor should abide by not only in volatile markets, but in any type of market:

1. Keep your losses small and cut your losses early, and
2. Let your profitable investments ride.

So why is it so difficult for the average investor to abide by these rules? With so much information so easily accessible today, the internet was supposed to level the playing field between the big boys and the small retail investor. It has, but conversely and unfortunately, it has also provided a medium for the big boys to mercilessly manipulate the inexperienced retail investor into making poor investment decisions as well. When you consider the vast ocean of information out there, at first glance, the task of sorting the very few gems of good information from the mountains of rubbish appears to be a daunting, nearly hopeless task.

During the last 12 months, for every person that said that U.S. and Shanghai markets were going to correct heavily, there were ten others that said that these markets were about to start another monumental bull run. For every analyst that said oil was heading to more than $100 a barrel when it was still trading at $60 a barrel, there was another analyst stating that $30 a barrel oil was just around the corner. For every person that said gold was heading to $1,000 an ounce when it was trading at less than $700 an ounce, there were ten that called gold bugs lunatics and said that gold would crash to $300 to $500 an ounce within a year.

In addition to these heaps of conflicting reports, numerous investment letters actually employ analysts that take opposition views, with one analyst calling for $30 oil and another calling for $100 oil, with one calling for a gold bull run and another calling for a gold crash, so that no matter what happens, they can spam thousands of people and falsely exclaim, “We were right again!” Finally, thousands of bloggers state opposing viewpoints about everything from stock markets in India to platinum and palladium markets, and thousands more agree and disagree with these bloggers’ opinions.

So who is one to believe and how is it possible to ever employ the two rules above when there are thousands of people in the media that provide conflicting advice and persuasive arguments to support their views?

The answer, believe it or not, is actually very simple. Find someone (or a few people) that has a track record of being correct almost all the time and follow him or her (or them) and ignore everyone else. Yes, the majority of people labeled as experts in the media and quoted most of the time in newspapers and TV are wrong the majority of the time. It’s not because these people are dumb. It’s because they have an agenda – they work for the big commercial investment industry machine in the sky and their singular purpose in life is to get you to buy any investment product they sell, whether or not such an action will jeopardize your financial future.

Just consider the following statistic. A Wall Street Journal survey conducted in the early 2000’s of U.S. economists that has been conducted since 1982 has shown that the economic experts surveyed have been correct about their future predictions of the economy at a rate less favorable than an outcome that would be produced by random guessing – 22%. Yet these are the surveys on which the retail investor bases his or her investment decisions.

A 1995 London Financial Times study revealed that “Consensus economic forecasts failed to predict any of the most important developments in the economy over the last seven years.” And a recent study on all Morningstar rated mutual funds discovered that the vast majority of fund managers have not a single penny invested in the own funds that they manage. It is quite clear that the consensus opinion reported in the financial media is not only quite often worthless, but quite often harmful to your financial health.

Almost a decade ago, before I had started up my own company, I was interviewed by a major Bay Area California investment firm with billions of assets under management. During my interview I disagreed with almost every consensus opinion of the economy that existed at the time. I could immediately tell that the interviewer was more than unhappy with my answers and needless to say, he did not hire me.

Although the next 12-months proved my views to be right, and his to be wrong, the unspoken reason this upper-level manager refused to hire me was obvious. If he were to hire me and I was just as vocal about my opinions while an employee of the firm as I was during my interview, well, this would be bad publicity for the selling propaganda machine.

Though I might have been right, and the interviewer may have even known I was right, I was very “wrong” for the bottom line of the firm. In the commercial investment world, the old Japanese saying of “a nail that sticks out gets hammered down” is very true. It takes consensus and collusion to fool thousands of clients into very bad decisions.

Because the political-investment complex has a narrow agenda to “sell you,” most investors have a grave misunderstanding of macroeconomic trends that keep the losses, instead of profits, growing in their personal accounts while the accounts of the commercial investment industry become fatter at your expense.

The political-investment complex happily spews nonsense into the media, blaming oil speculators for oil’s spectacular rise to more than $147 a barrel. It falsely attributes Iran’s test-firing missiles for gold’s re-test of $1,000 an ounce. And the masses of inexperienced investors eat this nonsense-up every day for breakfast while ignoring the reality that the U.S. Federal Reserve’s deliberate debasement of the dollar is the singular largest contributing factor to rising commodity prices and that global concerns about inflation is what causes gold to keep rising.

Because I’ve already developed my filters to uncover the economic truths that never make it to the surface, I’ve been recommending specific gold investments before gold was even trading at $600 an ounce (to my subscription members). And if you can sift through the nonsense, then it is quite simple to continue to understand where the profits will be made and where the huge losses will come from in the future.

As I stated above, you can’t go wrong in your investment strategies if you find someone that has a track record of being correct almost all the time and simply follow him or her and ignore everyone else.

Perhaps the opposite of this tenet is just as valuable – to ignore those that have consistently been wrong. If you had followed this simple tenet, you would have started ignoring almost every politician on the news after the second time they were very publicly wrong about the state of this economic crisis instead of listening to what they had to say the third, fourth, fifth, and sixth times they were wrong. If you had followed this simple tenet, you would start ignoring 99% of the people in the media spotlight today after discovering the second, third and fourth times they were wrong, and you would ignore the many investment newsletters that spam you about their amazing predictions when you discover that for every prediction they got right, they made 40 others that were terribly wrong.

If you’ve ever have successfully made a lot of money trading options and futures, then you know that by simply doing the exact opposite of what the “non-reportables” are doing, selling when they are the most bullish, and buying when the are the most bearish, you can have an exceedingly high success ratio on your option and future plays (the “non-reportables” constitute all the small investors with small positions, i.e. the average investor on the street).

That’s correct, the average, small investor is nearly wrong 100% of the time in his or her future and option plays. Too many people are too unduly influenced by all the “white noise” out there in the investment world today and trust me, there is a ton of white noise out there. But simply put, the “white noise” filter that will discard 99% of the poor advice out there is quite simple as I have explained above.

Lastly, there is one other horrible by-product of the political-investment complex of demagogues – hope. Yes, hope in the investment world can be an extremely destructive concept, especially during a bear market. It is hope that turns a 20% portfolio loss into a 40% portfolio loss and a 40% portfolio loss into a 60% portfolio loss.

Those in the investment world that have a narrow agenda to “sell you” will always provide you with a sliver of hope to “hang on,” despite the fact that you may have already suffered 20% to 40% losses over the past 12 months. They know that the greatest psychological weapon they can use against the retail investor is his or her ego. People hate admitting that they are wrong, and will grasp at anything that provides them with hope that they aren’t wrong.

Even though the smart thing to do if you were heavily invested in U.S. markets was to sell out of the rallies at the end of 2007, many retail investors are amazingly, as of today, still heavily invested in portfolios that mirror the major U.S. market indexes. Here are the exact words from my free investment newsletter that I sent out on November 15, 2007.

Use rallies like the one last Wednesday where the Dow piled on 300+ points in one session to sell out if for some reason you are still heavily invested in U.S. stocks. Even if the U.S. stock markets manage a sustained rally sometime within the next several months, it will only happen because the Feds aggressively slashed interest rates or the Working Group on Financial Markets is manipulating and massaging indicators behind the scene to allow this to happen. Any rally will not mean that the U.S. markets are on the way to recovery but merely that they are being set up for a greater fall. Of course, since most people psychologically feel comfortable behaving like barometers of the general consensus, and psychologically people fear taking an opposite stance from the rest of the crowd, they generally go with the flow to the detriment of their own portfolio performance.

Why? Because the political-investment complex keeps prodding them with hope, declaring repeatedly for the past 8-months that every lower low in stock markets is “really the bottom this time” to keep inexperienced investors invested in terrible markets. It’s the perfect psychological tactic. By spreading the word continuously for the past 8-months that markets have bottomed, this message feeds into the retail investors’ desire for a shot at redemption, for that chance to recoup losses and to prove to themselves that they weren’t wrong. At the same time, it allows the commercial investment industry to continue to make money at the investor’s expense.

By the way, how did the political-investment complex get the retail investor to stay invested in U.S. markets throughout 2007? The answer is quite simple once again - by harping on the other easy-to-manipulate fear of the inexperienced investor – the fear of losing profits. Back in 2007, when those heavily invested primarily in U.S. markets still had profits, the political-investment complex actively promoted the concept of “buying the dips” as opposed to selling the rallies.

Because people invested in U.S. markets were still profitable for a rolling 12-month period for most of 2007 and only started giving back some of their profits towards the end of 2007, the commercial investment industry easily was able to convince investors to pour more money into U.S. markets during dips at the end of 2007 by promoting this as a tactic to regain some lost profits even though this guidance would create greater losses by 2008. Simply appealing to the inexperienced investor’s fear of losing profits was all it took to cajole investors to do the wrong thing.

Again, the commercial investment industry will always exploit the inexperienced investor’s fear of getting left out in the cold and be able to convince many a naïve investor to remain heavily invested in poor markets. For example, read this article I penned almost three months ago where I warned about a steep correction in U.S. markets and the comments that follow.

While there are a few very astute comments, there are also a few comments that explicitly illustrate the easily exploitable fear of losing out on profits from the promise of another bull market. And it is this fear that can lead to terrible choices if one listens to the “white noise” of the investment community instead of coming up with a system to guide your investment strategy. Listening to the talking heads on Reuters or Bloomberg every day for guidance is not a strategy. Finding someone that is consistently on point with their predictions and following him or her is.

So use the proper filters and combine your newly found higher level of understanding of the global economy with these two rules:

1. Keep your losses small and cut your losses early, and
2. Let your profitable investments ride.

However, rule (2) only applies during bull markets, not bear markets. If you’ve been suffering losses throughout 2008, I guarantee you the application of this previous sentence will start turning your losses into profits.

Comments

[buyitcheap]

This is called winning by not losing - well argued. Enjoyed it.

[Bob Gary]

Very solid feedback. Much appreciated.

[Arnold Layne]

Reading the comments of 'bashers'on your past posts is very entertaining. Certain of them owe the author an apology.

[SPXPlus10]

Spot on. I worked at a rating agency. Being the nail leads to getting hammered... out the door, in my case! (The feeling of "good riddance to bad rubbish" was mutual, but I rest my case on the events in 2008.)

The difficulty of finding the "100% correct all the time" advisor is equal to finding the holy grail... there is no such person. Even Doug Kass (a conservative bear at TSCM), who has been right a very good number of times in the past 12 months, blew it on the financials this year - he has been calling for going long for way too long.

I think the best thing is to follow your rules and watch the market from a bit of distance: try to avoid the "minute" charts, or at least compare them to the perspective of the day and YTD charts. The street wants you to overtrade, when the reality is, anyone who bought SDS on January 1 and went to the beach (in the southern hemisphere first, and now here in the north...) would be laughing their way to the bank, pushing a wheelbarrow.

[fatcat]

So right,Ball..SDS and QUID have been my best plays of the year..without them,I would have been a loser.Thanks also goes to AAPL options played both ways..

[debtacid]

As a new self investor who recently dumped all his "professional advisers", my hardest task has been sorting out truth from lies. I learned quickly that most "financial news" is just cheer leading and the best way to predict the market is to watch the Fed and learn the history of the Fed. I have made more on my own in the last 10 months than my "pros" made for me in last 3 years. If I had kept them, I would be down over %50...

[El Mago]

How are you any different from the commercial investment industry with your "for subscribers only" tidbits and what not? I don't disagree with you in principle; however, the "for subscribers only" line sort of undermines your message. Why does this not qualify as "White Noise"?

[carey_jim]

Sometimes we forget the obvious, that the future is almost always difficult to predict.

Equally obvious is that it is dangerous to tell the emperor that he is wearing no clothes which translates:

Sometimes the truth is staring everyone in the face but almost everyone is trying hard not to see it.

And, sometimes almost everyone believes in a pack of lies which are usually called propaganda or advertising and sometimes just self-comforting illusion.

If it's clear that everyone is denying the truth about something and even actively pushing lies, that is usually an investment opportunity.

But the future (almost!) always remains difficult to predict. Denying that simple fact is the foundation of bad investment advice

[Takayama]

Very informative. Recommended reading for newbies.

Remember this human behavior :: Be a messenger of good news; and hide the bad news under the carpet.

Only an honest and righteous man is willing to listen and accept the facts, be they good or bad news thereby acquiring understanding and new knowledge.