Stock Investing Basics – for the probably stupid

by Rich Hamilton
February 3rd, 2010

There’s only one reason to invest in the stock market; you want to risk losing your money because you think you won’t. You’re probably stupid – Wall Street will empty your wallet and won’t even say thanks.

You’re crazy enough to think that you’re going to make more money in the stock market than from doing something you actually know something about.

Well listen stupid, finding good stocks shouldn’t be easy. If you don’t want Wall Street to fleece you, you’d better think about that for a minute.

I’ll say it again, louder, because you’re most likely hard of thinking: finding good stocks shouldn’t be easy.

But hey, you say, I’ve read [insert the title of the &^%^&* book that's just fooled you into thinking you're a financial genius]; I know I can make money with stock investing.

Yeah, yeah, sure you can. Just like I once read a book about football strategies and the next week I got a job coaching the Dallas Cowboys.

Stock Investing Basics

Rule Number 1

Don’t let Wall Street empty your wallet.

The smartest thing a stupid person like you can do is make sure you pay Wall Street the absolute minimum. Invest in the lowest cost index fund you can find. Since you’re stupid, it’s 95 percent likely you’ll be more successful doing this than anything else.

Stop Reading Now

Only read more if you’re determined to find out enough to start losing money.

Rule Number 2

Only allow Wall Street to empty your wallet slowly.

Okay, you’ve decided you’re going to ignore my best advice. You’re keen to increase your risk in the almost certainly futile hope that you can invest profitably in stocks.

Rule 2a. Buy and sell as infrequently as possible. That way you keep entry and exit costs down – fees and slippage. Also, most people time their market entries and exits badly. Making fewer buys and sells helps you lose money more slowly.

Rule 2b. Pay the lowest possible fees for your transactions. Depending on your circumstances, this might be with the Bank of America, which offers zero fee trades if your accounts have a total of $25,000, or, for example, OptionsHouse who do $2.95 trades or TradeKing who do $4.95 trades. Like anything, shop around for the best deal. Don’t be stupid enough to only look at my recommendations.

Rule Number 3

Get an advantage over Wall Street – Actually Make a Profit!!!

Yeah, we both know you’re stupid, but even stupid people are allowed to dream. It’s possible to beat the market, but don’t expect it to be easy. There are proven ways of doing it. They will work, if you’re smart and you’re willing to work hard climbing the learning curve and face the possibility of making losses while you learn. If you succeed, tell me about it. If you don’t, put it down to your own stupidity.

 

Stock Investing Basics – Five Ways of Making a Profit

The Micro Cap Approach

The basis of the method: On average, small companies have more room for growth than big companies. Investing in microcap companies (very small companies with a market value of $25 million or less) offers increased scope for capital growth. Historical evidence suggests that investing in a basket of microcap stocks is particularly fruitful for small investors.

Skills: Business/asset valuation skills for stock picking, or the finances to pick a large portfolio of microcap stocks.

Psychology: Logical business person.

Money Management: Buy and hold a number of assets. Rebalance the portfolio frequently, replacing companies that have grown and are no longer microcaps.

The Contrarian Approach

The basis of the method: Markets are mean reverting; they move to extremes and then return to their long term averages. The contrarian buys a cold market and sells a hot market.

Skills: The ability to tell whether a market is overcooked, underdone or somewhere in the middle. Contrarians generally look at both financials and market sentiment.

Psychology: A contrarian streak. You need to be comfortable holding a minority viewpoint. You need the strength of character to look at what most people and commentators are recommending, and then do the opposite.

Money Management: Contrarians tend to hold fire until they believe conditions are right and then invest significant proportions of their equity.

Some Potential Role Models: John Maynard Keynes, Sir John Templeton, Joe Kennedy, Warren Buffett.

The Statistical Approach

The basis of the method: Exploitation of non-random market patterns and mispricing of assets across markets; mathematical analysis of market behavior.

Skills: High level mathematics. The ability to read Lo and MacKinlay’s A Random Walk Down Wall Street without tearing your hair out. Computer modeling experience.

Psychology: Ideally you should not take decisions. Your computer model should take them all. This relieves you of the pressure of deciding when to enter and exit trades. You need to be able to hold your nerve during periods when your models are returning losses.

Money Management: Your models will incorporate sophisticated money management algorithms.

Some Potential Role Models: Ray Dalio, Victor Niederhoffer, Bill Dunn.

The Bandwagon Approach

The basis of the method: Get on a bandwagon and jump off before it crashes – trend following or momentum trading. Markets move in trends. If you trade in the direction of the trend, you can profit from it.

Skills: Appropriate timing of trade entries and exits. Timing is often determined by charting methods or with technical indicators.

Psychology: Self-confident; you need to have high confidence in your trading methodology. This will give you the fortitude to trade through losing runs.

Money Management: In general, you should only risk losing a very small amount of your total equity in any single trade.

Potential Role Models: Jesse Livermore (but not for money management!), Martin Zweig

The Value Investing Approach

The basis of the method: Buy assets when they are priced lower than true value. Hold until the market has re-priced the asset. Sell when they’re priced higher than true value.

Skills: Business/asset valuation expert.

Psychology: Bargain hunter.

Money Management: Buy and hold a number of assets. To prevent money being tied up too long in underperforming assets, set a time after which you will sell the asset if the market has not marked its price higher.

Potential Role Models: Benjamin Graham, Warren Buffett