November 5

7 Time Tested Rules about the Stock Market You Didn’t Know

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One of the best books I have read on the stock market is William O Neil’s How to make money in stocks. Most of my 7 times tested rules ideas actually come from there. It forms my foundation for my investment strategies.

  1. Fundamentals Matters

We need to understand the story behind every stock. After all, it’s a company managed by real people, not exactly all fungazi like what was stated in Wolf of the Wall Street. We should look at the last three years’ consensus earnings per share (EPS) to be increasing by at least 25% or more and is expected to be growing by a similar amount by analyst consents estimate in the next year. Buy a stock because the company is a leader in its sector and has good sales growth, Return on equity (ROE), profits margins as well as product superiority. Also look for companies who buy back 5 to 10% of their own stock. It is a good sign that they are trying to increase the value of their stock.

  1. Don’t buy a stock because it’s cheap or undervalued.

Stocks like a product, is cheap for a reason. It’s a sale, because no one wants it and the institutional investors are selling them to us (retail investors). Buying stocks should be buying those stock that the big players want, because it is the big players that will move the stock. As for undervalued stocks, I do not believe that there are much opportunities appear in public traded stocks, particularly those which are under media and institutional coverage. Private equity and small cap stocks may have undervalued opportunities and comes with huge risk and I have no idea how to find them. In fact, finding undervalued stocks has become so difficult that Buffet himself advice most people to buy an index fund and hold it for 40 years until they retire.

  1. Don’t buy a stock based on dividends or P/E ratio

Everyone loves dividends because ‘a bird in a hand is worth two in a bush’. I gives certainty to the investor who is holding the stock to feel like he/she is getting worth its money. What is better than to buy a stock even more as the expected dividend yield continues to grow as the price drops? Please understand that the dividend in the future could drop because it is likely that the company is currently no performing. Furthermore, most companies offer to pay dividends is because they cannot find better opportunities in their company to invest in a new project. At the same time, they make investors happy, which is killing two birds in one go. As for P/E ratio, it is ironic that we shouldn’t buy a stock based on P/E ratio. This is similar to the case of undervaluation. P/E ratio represents the popularity of the stock, therefore if a stock is not popular, it cannot have the potential of going higher. Essentially we are riding on the momentum of the stock, which may or may not necessary be a bubble. Once it is popped, many stocks never ever reach their historic highs ever again.

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  1. Never ever fall in love with a stock

Coca Cola, MacDonald’s, Apple all these blue chip stocks all had their time. Old investors who bought their stock long time ago will be quite rich and happy with the stock. But please understand that everyone, include a stock, has its prime. Stocks, at the end of the day, are just numbers that represent your profit. Would you want your money to evaporate away just because you love the stock? Think about Yahoo, and many other tech stocks during the 2001 .com bubble. 99% of their value and your money could be wiped off.

  1. Charting comes hand in hand with fundamentals

Fundamentals matters, but when the general market condition is not ready, the stock will never move. As the saying goes, when the tide rises, all boats will move with it. You want to ride on the tide, and the easiest way to identify this is to look at the daily and weekly charts. Every chart tells us a story. Look out for stocks that form a consolidating base and breakout.

  1. Never ever dollar cost average down a stock

This concept is like throwing money after the bad. You will be just losing money. Imagine in this case, you bought a stock at 80, then 60, then 40. But you do not know the bottom of the stock. The average of your price might be lower than what you bought. After all, you have limited capital. What is worse, is that the stock will never reach its high again. You can dollar cost averaging for a well-diversified fund or a country ETF, because in the long run, the markets will always recover. Not the same can be same for a stock.

  1. The market is always right.

Forget about your ego and pride; the market doesn’t care what you think or want. NO matter how smart you think you are, the market is always smarter. A high IQ and a master’s degree are no guarantee of market success. Your ego could cost you a lot of money. Don’t argue with the market. Never try to prove you’re right and the market is wrong.

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