The best stock market rules of thumb can help you make better investing decisions. Here’s a look at two of the best: The four-year rule and the sell-half rule
Stock market rules of thumb won’t guarantee investment success. But the best of them can be very useful in helping to boost your portfolio returns.
Here are two we like:
The Four Year Rule gets its name from the length of a U.S. president’s term of office. The rule says that an attractive buying opportunity appears in the stock market about every four years, starting just after the fall mid-term U.S. congressional elections (most recently held in November 2018).
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Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor.
How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.
The sell-half rule recommends that you sell half of a stock that doubles in price and you should be quicker to sell aggressive stocks than conservative stocks. It pays to apply our sell-half rule with stocks we rate as “Speculative” or “Start-up.”
Stock market rules of thumb: The Four-Year Rule
The four-year rule may sound familiar since we’ve written about it many times in the past few decades. In fact, it’s one of the most helpful market rules we’ve ever come across.
Here’s the short version: a particularly attractive buying opportunity appears in North American stocks about every four years, usually within a few months of the U.S. mid-term election (which most recently occurred in November 2018). Investors who buy around this time tend to make substantial profits over the next couple of years.
Most “market rules” turn out to be demonstrations of the fact that random events tend to occur in bunches. The four-year rule is an exception. That’s because it’s based on developments that tend to re-occur in predictable phases of the four-year U.S. Presidential term.
Here are some statistics worth considering. From the election of Andrew Jackson in 1832 till the re-election of Barack Obama in 2012, the U.S. went through 46 complete four-year Presidential terms. (The election of Donald Trump in 2016 marked the start of the 47th term in this series.)
In the first year (that is, the post-Presidential election year) of these 46 four-year presidential terms, the average result for the U.S. stock market was a gain of 2.5%. The average for the second year (the year of the mid-term election) was a gain of 4.2%; the average for the third year (the pre-Presidential election year) was a 10.2% gain; the average for the fourth year (the Presidential election year) was a gain of 6.0%.
You might say that a large majority of North American market gains have occurred in the second half of the four-year U.S. presidential term. The pre-Presidential election year had the biggest average gain. In addition, the U.S. market has gone up in almost all of the last 19 or so pre-election years.
In contrast, the market has gone up in just over half of the past 19 or so post-election years, 12 of the 19 or so mid-term years, and about five of the last Presidential election years.
This pattern probably comes about because of a couple of unchanging things about virtually all U.S. Presidential elections:
First, virtually all U.S. political office holders, regardless of party, want to get re-elected, or pave the way to the election of a successor from their own party.
Second, U.S. Presidential elections bring out many “swing voters” who might not vote in less important elections.
When things are going well for swing voters, they tend to favour the current officeholder, regardless of party. This means current U.S. political officeholders have an incentive to make swing voters happy during U.S. Presidential elections, even if it means cooperating with the opposing party. They start work towards that goal around midway through the four-year U.S. Presidential term, around the time of the mid-term election.
That’s why newly elected or re-elected presidents introduce unpleasant necessities—such as the need to confront China—in the first year or at least first half of the term. Swing voters (or voters generally, for that matter) will have had time to get over the shock of the news before the next Presidential election. In fact, the unpleasant necessities of the first half of the term may be paying dividends by that time.
Stock market rules of thumb: The sell-half rule can be helpful to aggressive investors
Selling half of hot stocks that surge helps you guard your profits. But in general, apply this rule only to more aggressive stocks, and not to the well-established stocks that may surprise you by going a lot higher in the long run.
Selling half after a stock’s price doubles makes sense in a high-risk investment such as a penny mine. That way, you get back your initial stake. This can give you a clearer perspective on what to do with the other half of your investment. If you are too slow to sell speculative stuff, after all, your profits and even your principal can evaporate all too quick.
However, as mentioned, it’s a mistake to apply this rule to your best holdings that are not high-risk investments. To succeed as an investor, you need to hold on to your best picks for lengthy periods. If you’re too quick to sell, you’ll never hold a stock that vastly outperforms the market, and you need a few of those to offset the inevitable disappointments.
What stock market rules of thumb do you follow while making stock picks?
Have you used a stock market rule of thumb that led to a big loss? What happened?