In his book, “Just One Thing: Twelve of the World's Best Investors Reveal the One Strategy You Can't Overlook,” John Mauldin turned to a dozen accomplished investors. He asked each of them to write an article about the single most important rule they’ve learned.
Dennis Gartman was one of the group that contributed to that 2006 book. At that time, he had more than three decades of trading experience, had been publishing the widely-read Gartman Letter daily for nearly 20 years and was a regular commentator on CNBC and other media.
There was no mistaking his perspective from the very first sentence of the article: “The world of investing/trading, even at the very highest levels, where we are supposed to believe that wisdom prevails and profits abound, is littered with the wreckage of wealth that has hit the various myriad rocks that exist just beneath the tranquil surface of the global economy.”
So it’s a dangerous world out there for investors. What are we to do? Well, first recognize that Gartman is not a value investor, so he’s not counting on intrinsic value. And, based on his commentary in this article, practices momentum or growth investing; that means he tries to keep buying into rising prices.
Out of his experience, he came up with a long raft of rules, rather than just one. Some, to be fair, are variations of others, and with a little mental wrangling, they might all be subsumed under one rule. And, he made no apology for his rules, writing, “When I do stand by my rules, I prosper; when I don’t, I don’t.” What’s more, he conceded he has made “preposterous errors of judgment” as well as “wonderously insightful” plays.
His first rule? Never add to a losing position. He wrote, “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.”
Those among us who are value investors would likely jump in to ask about the quality of the stock involved. Is this a good company that’s suffering temporarily because of bad news, or is this a company of questionable quality? If the latter, then we would agree with Gartman. However, buying stocks that are cheap or getting cheaper is a foundational element of value investing, always with the proviso that it is a good company and that we are prepared to wait for it to recover.
Just to emphasize this rule, rule number two is the same, “Never, ever, under any circumstance, should one add to a losing position...not EVER!”
Rule number three is to trade on the side that is winning. He invoked the memory of Jesse Livermore, who said that we should not trade on the bullish side nor the bearish side—we should only trade on the winning side. Go long when the market is bullish, go short when the market is bearish. He wrote,“Capital is in two varieties: Mental and Real, and, of the two, the mental capital is the most important.”
Rule number one is another variation on rule number one, about never adding to a losing position. In this case, Gartman argued that an investor can become mentally exhausted by holding onto a losing trade, “becoming more and more fearful with each passing minute, day, and week, avoiding potentially profitable trades while one nurtures the losing position.”
Moving on to rule number five, he wrote, “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.” This rule provides more evidence that Gartman is a momentum investor and not a value investor. His rationale is that while we can never know what price is really low or really high, we can observe trends and act upon them.
He added this point that should be kept in mind by all investors: “The lesson here is that we really cannot tell what is high and/or what is low, but when the trend becomes established, it can run much farther than the most optimistic or most pessimistic among us can foresee.” Certainly, the bull market we’re in has gone on longer than most expected, more than 10 years now.
In rule number six, he recommended that investors sell in markets that are showing the greatest weakness and buy in markets showing the most strength, and is thus a variation on rule number three.
Rule number seven urged readers to avoid what seem to be “logical plays.” For example, if a stock rapidly rises in price, don’t presume it will correct itself in the near future.
John Maynard Keynes was the source of rule number eight. The British economist wrote, “Markets can remain illogical far longer than you or I can remain solvent.” That, of course, is a variation on rule number seven.
Traders can take note of rule number nine, which argued that trades go in cycles, some that are good and some that are bad. And, you can’t do anything about them.
Getting to the heart of rule number 10 is a bit of a challenge. Gartman insisted it is essential that investors and traders must understand both the economic fundamentals and technical analysis as well. He posed a couple of rules to follow if the fundamentals and the technicals point in different directions.
Following up on that idea, rule number 11 told us we must keep our technical systems simple. If you’ve ever puzzled over complex charts, you’ll understand when Gartman said that the greatest traders and investors he’s known used simple technical indicators such as trend lines.
Rule number 12 referred to the wisdom or foolishness of the crowd; he wrote, “In trading/investing, an understanding of mass psychology is often more important than an understanding of economics.”
Most important, Gartman argued, was rule number 13: “Do more of that which is working and do less of that which is not.” This is the rule that seems to sum up most or all of the other rules, depending on that mental wrangling I referred to earlier. As the author conceded, it’s an easy thing to write, but a difficult rule to act upon. He added that it is also an excellent rule for life.
He wound up his article with these words:
“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.'”
In chapter two of “Just One Thing: Twelve of the World's Best Investors Reveal the One Strategy You Can't Overlook,” Gartman gave us a baker’s dozen of investing rules, which he developed over a distinguished investing career.
As we’ve seen, he is a momentum investor, not a value investor. Yet, there are insights to be gained from his article that will be worth the time of all investors.
The most important of those insights, I would argue, is the need for a set of investing rules, whatever our approach. Second is the recognition that we will at times break our own rules, but what matters is learning from them and moving on again.
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Robert AbbottRobert F. Abbott has been investing his family’s accounts since 1995 and in 2010 added options -- mainly covered calls and collars with long stocks.He is a freelance writer, and his projects include a website that provides information for new and intermediate-level mutual fund investors (whatisamutualfund.com).As a writer and publisher, Abbott also explores how the middle class has come to own big business through pension funds and mutual funds, what management guru Peter Drucker called the unseen revolution.
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