Seven Investing Rules Of The Pros That Everyone Who Trades On The Stock Market Should Know

Getty / Sean Gallup

Billionaire hedge fund manager and philanthropist George Soros – the man who it’s said broke the Bank of England back in the 1990s – once wrote that “successful investing is a kind of alchemy”.

If that is the take of one of the Lords of Finance and a man who has amassed many billions of dollars for himself and his clients, what hope has an average investor got in making a success of managing their super or their private investments?

On the face of it not much, but contrary to Soros’ view, trading doesn’t have to be alchemy. It can be simply a process.

What process can your average investor follow to help guide his or her decisions?

Thankfully one of the world’s best investment strategists, member of global fund manager GMO’s asset allocation team and visiting fellow at the University of Durham, James Montier, summarised the process of investing into “The Seven Immutable Laws of Investing”. They are:

  1. Always insist on a margin of safety
  2. This time is never different
  3. Be patient and wait for the fat pitch
  4. Be contrarian
  5. Risk is the permanent loss of capital, never a number
  6. Be leery of leverage
  7. Never invest in something you don’t understand

Let’s go through them one by one.

Margin of safety

This means different things to different people. But at its essence it means do your homework.

Look at the business of the stock you are investing in, look at the P/E now and in the future, understand the drivers of the business. If investing in bonds or hybrid instruments know the true risks associated with the security you are looking at.

In short, know what you are investing in, know why you are investing in it, and if the answer is “because everyone else is” – then don’t.

It’s never different

Companies come and go.

Technologies come and go and move through their lifecycle.

Railroads, the motorcar, the telegraph, the “wireless”, televison, the internet – each different but each in some way speeding up the way humans communicate. With some of these innovations have come bubbles and with some, crashes.

The similarities in all cases – human emotion and greed crowding the sound investment principles of rule number one.

The fat pitch

The fat pitch is baseball parlance for an easy hit. In cricket terms it might be a ball with a little width outside off stump that you can thump to the boundary.

Either way its really just about waiting and being cautious because the enemy of successful investing is time, boredom and feeling that you have to do something.

In the modern investment universe time gets compacted by the amount of data coming at investors every minute of the day from all corners of the earth. Decisions feel like they need to be made in a hurry.

But successful investors know how to step back from the crowd and find clarity in the noise. They know how to wait.

Be a contrarian

One of the world’s most successful investors, John Templeton, is famed for his contrarianism and for having a list of stocks and the levels he would buy them at if they fell to those levels.

This is a great rule to have for some part of your available investing funds because it allows you to keep your head while all around you are losing theirs.

Under this rule you would have been buying stocks in January to March 2009 when others were panicking and selling.

Commonwealth Bank at $27? That’s investing.

Risk is the loss of capital not a number

If you lose 20% of your capital you need to make 25% to get back to where you were. If you lose 50% then you need to make a 100% return to get back to square.

Smaller investors probably understand risk better than the professionals who often boil risk down into a theoretical mathematical construct which abstracts the fact that its actually making and losing money that matters when you are investing.

In real terms risk is what might happen if you don’t follow these rules and then lose some or all of your capital.

Be leery of leverage

When you borrow to invest, whether to buy a house or to purchase shares, you increase your leverage. This means any move higher in prices is multiplied as a percentage return on your capital invested. But it also means if prices fall too far you can lose all your capital and be wiped out.

Margin lending for stocks is a legitimate way to increase returns but it is judicious use of leverage – not too much – which can allow you to adhere to rules 1, 3 and 5.

Never invest in something you don’t understand

This is both its own rule and a summary of all the above rules.

You don’t need to understand how iron ore becomes steel to buy BHP and you don’t need to under stand the intricacies of the latest biotech protocols to invest in a new company.

But this rule does mean you need to understand the company, the market it operates in and the risk around its business before you invest in its shares, bonds, hybrids or any other market.

Once again investors have to do their homework – success isn’t guaranteed but it’s more likely if you know what you are investing in.

If you are interested in getting started in the share market, explore CommBank’s new online investment platform, MyWealth. MyWealth is designed to simplify share investing, and make it accessible to everyone.

Choose from a wide range of investment opportunities and access all the research, news and tools you need to make informed decisions. Find out more.

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