Rules
More volatility. More worry about rising interest rates. Markets turned that worry into declines of 2.4% for the S&P 500 and 3.2% for the Nasdaq last week.
In a 2018 interview on The Knowledge Project Podcast, author and professor of behavioral economics Dan Ariely discussed how having rules for ourselves can help protect us:
Having rules actually protects us. Imagine you invited me to do something and I said, “I’m sorry. I have a rule. I don’t give more than 10 talks a year, or I don’t do X, or Y, or Z.” You would not feel good saying, “Oh, would you please break your rules once for me?” The moment you have a rule, you basically are elevating something for yourself and for other people. You are creating a standard from it and it helps you protect yourself.
Good investors have rules too. These could be things like limits on position sizes, the amount of work that needs to be done before committing capital to an idea, the industries one is willing to invest in, etc.
Investing rules vary from person to person, and some have more rules than others. But given the importance of psychology to the investing process, and how easy it is to tell yourself a story or fall for someone else’s story, having rules can make a big difference.
The process, and importance, of using rules is also discussed in one section of the book What I Learned Losing a Million Dollars:
Analysis is simply that: analysis. It doesn't tell you what to do, or when to do it.
In order to translate your analysis into something more than mere commentary, you need to define what constitutes an opportunity for you. That's what rules do; they implement your analysis. Rules are hard-and-fast. Tools (i.e., methods of analysis) have some flexibility in how they are used. Fools have neither rules nor tools. You must develop parameters that will define opportunities and determine how and when you will act. How? By doing homework (i.e., research, testing, trial-and-error), and defining the parameters with rules. Your homework determines what parameters or conditions define an opportunity, and your rules are the "if ... , then ..." statements which implement your analysis. This means entry and exit points are derived after you have done your analysis.
If the opportunity-defining criteria aren't met, you don't act. This doesn't mean a particular trade or investment which you pass up won't turn out to be profitable. It might have been an acceptable and profitable trade based on someone else's rules. Remember, participating in the markets is about making decisions, and as Drucker reminds us, "There is no perfect decision. One always has to pay a price which might mean passing up an opportunity." You have to accept the fact that profitable situations will occur that you won't participate in. Don't worry about the ones you miss; they were someone else's. Your rules will only enable you to participate in some of the millions of possible opportunities, not all of them.
Have you established rules for yourself? If markets remain volatile, and the environment that both the economy and the stock market will be operating in going forward—with higher interest rates—is far different from what we’ve experienced during the last 15 years, those rules could keep you on the right path (and out of trouble).
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