This is a retread post from my blog. It was originally posted on March 8, 2008. As a follow on to my evangelizing the utility of a blog, I wanted to say that I was able to search for these rules and retrieve them instantly. I hope that you find these useful to your trading education.
My best girlfriend's in-laws
have a really neat cabin on the Potomac river. It is on a point on a
creek off the river, and just a beautiful, restful place. During our
first visit, my daughter was a toddler. There was water all around, and
as any of you know, despite one's best efforts, children do manage to
separate themselves from you. One only has to pick up the paper to see
the tragic consequences.
It's hard to explain drowning to a
toddler. So I adopted a tactic that would make the results of her going
into the water abundantly clear. I took her to the water. I explained
that it was deep and that she could not swim. I then said, "If you get
in the water and sink; you will turn blue and die." I asked if she
understood that. Now, I did not tell her any of this to give her
permission to wander around with this graven image in her head while I
kicked back and had cocktails. Rather, I wanted her to understand the
consequence of venturing into the water without a parent.
With
respect to investing and trading, all of us read the admonitions of
experienced folks that give us a list of warnings. We all read them.
Some read them and think that they are immune to them. Dennis Gartman
has a widely published list of rules that I thought I would resurrect. I
picked these up from The Big Picture (Barry Ritholtz's blog) which he published from John
Mauldin's newsletter.
To keep within the theme of this post, I
would title these: Dennis Gartman's Rules of Trading: If you break
them, your portfolio will turn blue and die"
R U L E # 1
Never, ever, under any
circumstance, should one add to a losing position … not EVER!Averaging down into a losing trade is the only thing that will
assuredly take you out of the investment business. This is what took
LTCM out. This is what took Barings Brothers out; this is what took
Sumitomo Copper out, and this is what takes most losing investors out.R U L E # 2
Never, ever, under any
circumstance, should one add to a losing position … not EVER!We trust our point is made. If "location, location, location" are
the first three rules of investing in real estate, then the first two
rules of trading equities, debt, commodities, currencies, and so on are
these: never add to a losing position.R U L E # 3
Learn
to trade like a mercenary guerrilla.The great Jesse
Livermore once said that it is not our duty to trade upon the bullish
side, nor the bearish side, but upon the winning side. This is
brilliance of the first order. We must indeed learn to fight/invest on
the winning side, and we must be willing to change sides immediately
when one side has gained the upper hand.R U L E # 4 DON'T
HOLD ON TO LOSING POSITIONS
Capital is in two varieties: Mental
and Real, and, of the two, the mental capital is the most important.Holding on to losing positions costs real capital as one's account
balance is depleted, but it can exhaust one's mental capital even more
seriously as one holds to the losing trade, becoming more and more
fearful with each passing minute, day and week, avoiding potentially
profitable trades while one nurtures the losing position.R
U L E # 5 GO WHERE THE STRENGTH IS
The objective of
what we are after is not to buy low and to sell high, but to buy high
and to sell higher, or to sell short low and to buy lower.We
can never know what price is really "low," nor what price is really
"high." We can, however, have a modest chance at knowing what the trend
is and acting on that trend. We can buy higher and we can sell higher
still if the trend is up. Conversely, we can sell short at low prices
and we can cover at lower prices if the trend is still down. However,
we've no idea how high high is, nor how low low is.R U L
E # 6
Sell markets that show the greatest weakness; buy
markets that show the greatest strength.Metaphorically,
when bearish we need to throw our rocks into the wettest paper sack for
it will break the most readily, while in bull markets we need to ride
the strongest wind for it shall carry us farther than others.R
U L E # 7
In a Bull Market we can only be long or
neutral; in a bear market we can only be bearish or neutral.In
a bull market we can be neutral, modestly long, or aggressively
long–getting into the last position after a protracted bull run into
which we've added to our winning position all along the way. Conversely,
in a bear market we can be neutral, modestly short, or aggressively
short, but never, ever can we–or should we–be the opposite way even so
slightly.R U L E # 8
"Markets can
remain illogical far longer than you or I can remain solvent."The University of Chicago "boys" have argued for decades that the
markets are rational, but we in the markets every day know otherwise. We
must learn to accept that irrationality, deal with it, and move on.R U L E # 9
Trading runs in cycles; some
are good, some are bad, and there is nothing we can do about that other
than accept it and act accordingly.Thus, when things are
going well, trade often, trade large, and try to maximize the good
fortune that is being bestowed upon you. However, when trading poorly,
trade infrequently, trade very small, and continue to get steadily
smaller until the winds have changed and the trading "gods" have chosen
to smile upon you once again.R U L E # 10
To
trade/invest successfully, think like a fundamentalist; trade like a
technician.It is obviously imperative that we understand
the economic fundamentals that will drive a market higher or lower, but
we must understand the technicals as well. When we do, then and only
then can we, or should we, trade.R U L E # 11
Keep
your technical systems simple.The greatest
traders/investors we've had the honor to know over the years continue to
employ the simplest trading schemes. They draw simple trend lines, they
see and act on simple technical signals, they react swiftly, and they
attribute it to their knowledge gained over the years that complexity is
the home of the young and untested.R U L E # 12
In
trading/investing, an understanding of mass psychology is often more
important than an understanding of economics.Markets are,
as we like to say, the sum total of the wisdom and stupidity of all who
trade in them, and they are collectively given over to the most basic
components of the collective psychology. The dot-com bubble was indeed a
bubble, but it grew from a small group to a larger group to the largest
group, collectively fed by mass mania, until it ended. The economists
among us missed the bull-run entirely, but that proves only that markets
can indeed remain irrational, and that economic fundamentals may
eventually hold the day but in the interim, psychology holds the moment.And finally the most important rule of all:
R U L E
# 13
Do more of that which is working and do less of
that which is not.This is a simple rule in writing; this
is a difficult rule to act upon. However, it synthesizes all the modest
wisdom we've accumulated over thirty years of watching and trading in
markets. Adding to a winning trade while cutting back on losing trades
is the one true rule that holds–and it holds in life as well as in trading/investing.Dennis Gartman: This
is what I have learned about the world of investing over three decades.
I try each day to stand by my rules. I fail miserably at times, for I
break them often, and when I do I lose money and mental capital, until
such time as I return to my rules and try my very best to hold strongly
to them. The losses incurred are the inevitable tithe I must make to the
markets to atone for my trading sins. I accept them, and I move on, but
only after vowing that "I'll never do that again."
