Understanding the basic rules for investing in the stock market will help guide you to better returns throughout your investing career
Are you interested in learning the basic rules for investing in the stock market? Like a lot of beginning investors, I took an early interest in “market lore”—rules for making money in the stock market. These rules aim to tell you how to spot good stocks to buy, good times to buy or sell them, how much to pay, etc. Most of these have gone through periods of success, of course—they seemed to work, so they attracted a following. None worked consistently, however.
Market rules like these try to make sense of statistics that are subject to a large random influence. When they succeed, it reflects a series of coincidences. (One of our first principles on investing is that random events tend to occur in bunches.)
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However, some rules are valuable because they help you recognize what’s going on with processes related to transactions and markets. The most consistently valuable rule I ever came across was the one about “spot the sucker.” If you’re a poker player, you may recognize it as an adaptation of an old poker rule: “If you can’t spot the sucker after half an hour in a poker game, you should drop out, since the sucker is probably you.”
Understanding the basic rules for investing in the stock market through the lens of poker
The investor version of this “spot-the-sucker rule” has been attributed to Jesse Livermore, a stock trader who made enormous sums of money during a lengthy but on-and-off winning streak in the first third of the 1900s. (He committed suicide in 1940.)
In poker, the “sucker” is the least skilled player(s) in the game. Like all poker players, suckers have good and bad hands, good and bad nights, and winning and losing streaks. But the sucker wins less when his luck is running with him, and loses more when it’s running against him.
The sucker’s losses “feed the pot”. They provide the money that gets won by the more skilled players. Good players also have good and bad hands, good and bad nights, and winning and losing streaks. But they win more when they win, and lose less when they lose. In the long run, their winnings mostly come from the suckers’ losses.
In investing, the stock market takes the place of the sucker. The difference is that in poker, the sucker contributes his own money to the pot, to be distributed among the better players. In investing, the market feeds the pot by distributing the profits that public companies create over long periods in prosperous countries. These profits go to shareholders, although other participants—brokers, promoters and so on down the line get their cut first.
Recognize that the basic rules for investing in the stock market can change, and you will be better positioned to thrive
You might say there are two kinds of investment rules that can help you with investing decisions—soft and hard. Soft rules apply to things that can change such as laws about securities and other financial matters, accounting procedures, industry practices, technological development and so on. Soft rules can remain fixed for lengthy periods, but they are always subject to change. Changes can come abruptly or gradually.
Hard rules come out of human nature. They are much more fixed than soft rules, and they never really change. But hard rules are more like tendencies than laws. Other considerations can temporarily overshadow or neutralize them, so much so that they seem to have disappeared. However, their disappearance is only temporary.
The basic rules for investing in the stock market include our three-part Successful Investor approach
You need to keep in mind that any long-term gain you make in the stock market comes from the profits of public companies you’ve invested in. We designed our three-pronged Successful Investor approach to tap into these profits:
Invest in high-quality, mostly dividend-paying stocks;
Diversify across most if not all the five main economic sectors;
Avoid or downplay stocks in the broker/media limelight.
Many investors have found our system does a great job for them, by helping them find the best investments for long-term portfolio gains.
The system also helps you spot “no-win” investment opportunities. One of the best examples I know of is options trading.
Stock options are investment products that give you the right but not the obligation to buy a stock for a fixed price, within a fixed time period. Stock-options trading is a great deal for brokers, because options investors pay much higher commissions than stock investors; they also pay commissions more frequently. That’s why options trading is a bad deal for investors.
Of course, a handful of options investors do make money—after all, somebody has to win the lottery. But on average, you just can’t make enough of a gross profit to pay the commission costs and leave yourself with any significant gains. That’s why most options investors wind up losing money.
What if any strategic have you developed in approaching options trading?
Is there one rule, or one set of rules, that you have used to successfully invest in the stock market?
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