It seems that there are many “first rules” of investing.
You’ve probably heard many of them.
“Cut short your losses; let your profit run on” is one rule that dates back to economist and trader David Ricardo in the 18th century.
Today I want to share with you arguably the most counterintuitive – yet simplest – rule of investing.
Ironically, it is the one investors follow the least.
That’s because it’s less about what you should do as an investor and more about what you shouldn’t do.
Let me explain…
How “This Time It’s Different”
I recently saw an interview with billionaire trader Stanley Druckenmiller.
He was asked to compare today’s trading frenzy with the dot-com boom (and bust) of the 1990s.
He said the most significant difference was the level of participation by retail investors.
Yes, the dot-com boom gave rise to a new generation of day traders.
But today’s superior technology platforms, zero-commission trading and 24/7 market access via mobile phones have taken that level of participation to the next level.
A whole generation of new traders has grown up playing video games. To these traders, the financial markets are simply a real-life version of those.
And their goal in trading is to “score more points” by mastering the rules of the game.
But here’s what these newbie traders don’t get: The markets are far more complex and unpredictable than the rules of any video game.
And the more (poor) decisions these newbie traders make, the more money they will lose.
The Wisdom of Not Playing
Contrast the newbies’ hyperactivity with the time-tested advice of the world’s most successful investors.
In his interview in Jack Schwager’s Market Wizards: Interviews With Top Traders, Jim Rogers revealed that he makes very few decisions.
Rogers’ success is not the result of sitting in front of a screen all day playing a game. It’s about having the discipline not to make many decisions at all.
As Rogers put it, “I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up.”
By waiting for opportunities where everything lines up, he makes far fewer mistakes.
Warren Buffett advises the same thing, using a typical folksy baseball metaphor…
In investing, I’m in a no-called strike business, which is the best business you can be in… I can pick the ball I wanna hit. The secret to investing is to sit and watch pitch after pitch go by and wait for the one in your sweet spot. If people are yelling, “Swing, you bum!” ignore them.
Alas, ignoring the yelling in today’s noisy world is hard to do.
The Market of the Apes
Today, you have more information in your pocket than the president of the United States had access to 20 years ago.
But more information doesn’t lead to more wisdom any more than giving a teenager a set of golf clubs turns him into Tiger Woods.
As late Harvard economist John Kenneth Galbraith pointed out, every 20 years or so a new generation of traders emerges to proclaim “a new era.”
Today, millions of newbie investors pile into “meme” stocks like AMC Entertainment (NYSE: AMC).
There are dozens of channels on YouTube run by these newbie investors. Some have attracted tens of thousands of followers – who refer to themselves (without a hint of irony) as “apes.”
Consider the example of smooth-talking Kevin Paffrath. This recent UCLA grad morphed from a real estate broker into a day trader with 1.6 million YouTube subscribers. (As a side project, he is also running for the governorship of California.)
YouTubers mock the experts, and they flaunt their inexperience with pride.
Psychologists dub this type of behavior “unconscious incompetence.”
Put another way, they don’t know what they don’t know.
Yes, the market has changed because armies of apes can drive a single stock sky-high from behind their keyboards.
But there is one thing that has not changed. And that is human psychology.
And the same story of boom and bust will repeat itself as long as humans (or apes) drive the market.
I don’t know when the current mania will end. But I do know how.
I’ll leave the last word to Warren Buffett: “A pin lies in wait for every bubble… Speculation is most dangerous when it looks easiest.”