Discipline & A Few Considerations

Notes On Discipline 

1. We believe it is better to invest in companies that have a history, like most of the companies in The Valuator, rather than in new companies which have a lot of "sizzle" but no history of valuation in the market.  In our own work, we correlate market performance of a stock with the financial performance of its company over corresponding years to construct a valuation model for the stock.  That way, we have a model that reflects how investors have typically valued the earnings, etc., of a company.  Investors value a dollar of earnings generated by a candy company differently than they value a dollar of earnings generated by a biotech company.  That is why we prefer companies/stocks that have a history.  Stocks with a history can swing up and down by 20% or more several times a year (resulting in great potential for profit for a disciplined investor), and your "buy" and "sell" decisions can have a much more rational basis.  With companies that have a history, it is much easier to determine if their shares are under-priced or overpriced.  New "sizzle" situations are exciting but they can make difficult the attempts of investors to be disciplined (emotions often get in the way of executing a disciplined approach).  Over time, reason will be a better guide than adrenaline.

2. Because all stocks cycle between being over-priced and under-priced, there should be more than enough companies in The Valuator to enable most investors to find good purchase candidates at any given time.  The exception might be some short-term traders who must exercise more precise timing on their entry points (see StockAlerts).  If there are no good purchase candidates available, the market is probably too high and risky, and cash should be preferred anyway.  Buying just to be in the market can be a big mistake.

3. Purchasers of options can improve their discipline (and results) by considering whether a stock is low or high from a fundamental perspective.

4. Chart watchers can improve their results by combining technical with fundamental considerations.  For example, the "double bottom" formation is far more attractive when the stock is undervalued than when it is overvalued.

5. It is hard enough to invest successfully with a good discipline.  Without discipline, we think you might do as well in Las Vegas--and more quickly.

Even the best strategies will produce some losers.  In a portfolio of 12 stocks, four might be rising, four might be declining, and four might be drifting sideways.  On the other hand, half might be rising and half might be falling.  Portfolio experts know that from 35% to 50% of the stocks they select will drop in value after their selection, even though they have tried their best to pick only winners.  Prudent investors do their best, but they always prepare for the worst.  Top traders feel elated if 60% of the stocks they buy rise and only 40% decline. Though this writer has been investing for decades, and though sometimes all his positions are rising, at the last calculation his average success rate it was just shy of 70% (70% rose and 30% fell).  It is possible to do better with extremely rigid adherence to a finely honed discipline.  For example, one of this author’s disciplines has better than a 90% success rate.  However, it is extremely rigorous, requires 13 filters, and is very demanding psychologically.  It is more work than fun.

A high succes rate can only be achieved by paying careful attention to technical "setups."  It is simply a "fact of life" for investors that many of the stocks they select will decline, and professionals compensate for this reality of the market by diversifying their portfolios.  Also, a person can have a success rate of less than 50% (more than half the stocks go down) but still be extremely profitable if a discipline that controls losses and lets profits run is employed.  If you select only two or three stocks in which to concentrate your assets, you may be choosing the three out of ten destined to decline. However, if you select enough stocks that your portfolio becomes sufficiently representative of your strategy, then the performance of your portfolio will be more likely to reflect the strategy you are using rather than the "luck of the draw" in selecting only a few stocks.  In general, we believe investors should select at least ten stocks to assure an adequate representation of their strategy.  Experienced traders might opt for a much smaller number of positions, but they are expert at managing the risk involved in doing so (these strategies may be discussed at some other time).

So, what else can a person do to improve his success rate?  Focus on setups.  Setups dramatically increase the odds that you will be on the right side of the trade, and that the stock will move favorably very soon if it has not already started to do so.  Near the bottom of the Stock Alerts page are illustrations of some setups.  You will have to scroll down after clicking on the following link.  Stock Alerts.~ Dr. Felt

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