Keep Investing Simple.
We have one recommendation as you start your investing experience...
Keep Investing Simple.
Investing is a simple concept. In fact, investing should always remain simple, despite your best efforts to muddy the water by trying out different strategies and concepts. In this book, you will learn to keep investing simple by asking three basic questions before you invest:
1. What is the purpose of investing? (Is my action consistent with the purpose?)
2. How do you make money investing? (Does this investment meet the criteria?)
3. What is the probability of success? (Does the probability justify risk?)
What is the Purpose of Investing? What is the purpose of investing? Let’s jump right in with the first question: what is the purpose of investing? In simple terms, investing is making your money to work for you. Investing is a different way to think about making money. Growing up, most of us were taught that you make money by getting a job and working. Which is exactly what most of us do. However, you run into a problem if you want to make more money than your job is paying. To earn more money than your current job pays, you have two basic options: work more or ask for a raise! Work More. You can work more to make more money. The problem comes when you run out of hours, energy or jobs to
work! Besides having extra money is no fun if you don’t have the time to enjoy it. Ask for a Raise. You might ask for a raise. I admit that most people are underpaid. As a first step in making more money, I recommend asking your employer to pay you a better wage. I am not promising anything, but give it a try! The problem with asking for a raise, is that even if you are successful in getting a raise, you will eventually reach a point where you max out your income, both in terms of hours worked and skills provided. Then what? Invest. Another easier (and more enjoyable) way to make money is to send an extension of yourself - money - to work on your behalf. This way, while you are putting in hours for your employer, mowing the lawn, sleeping, reading the paper or socializing with friends, your money will be hard at work earning more money! Making your money work for you expands your earning potential whether or not you receive a raise, decide to work more or ask for a higher-paying job.
Investment Vehicle There are many ways you can go about making your money work for you. Some of these include putting money into stocks, bonds, mutual funds, or real estate (among many other things), or starting your own business. Where you put your investment money to work is called an “investment vehicle.” Right up front, you need to know that every investment vehicles has it’s positive and negative which are often called risk and rewards! You’ll learn more about risk and rewards as we explain how to pursue your investing goals. Before you invest, you need to understand that it doesn’t matter which investment vehicle you choose, the goal is to put your money to work so it makes more money! Even though this is a simple concept, it’s the most important concept you need to understand to become a profitable investor.
Investing vs gambling. The definition of investing is the polar opposite to gambling. Gambling is putting money at risk by betting on an uncertain outcome with the hope that you might win money. Part of the confusion between investing and gambling, however, may come from the way some people use investment vehicles. For example, it could be argued that buying a stock based on a “hot tip” you heard at the water cooler is essentially the same as placing a bet at a casino and I would agree. Investing is not a get-rich-quick scheme. Which brings up the first litmus test of simplicity: is my activity consistent with the purpose of investing. If you are looking at an investment as a means to making a lot of money fast, then you are violating the first test in keeping things simple. True investing doesn’t happen without some action on your part. A “real” investor does not simply throw his or her money
at any random investment in hopes of a big payout; investors performs thorough analysis and commits capital only when there is a reasonable expectation of profit. Yes, there still is risk, and there are no guarantees, but investing is more than simply hoping Lady Luck is on your side. As a rule of thumb, anytime I utter or think the word hope about an investment, a red flag instantly goes up in my mind. Hope does not inspire confidence. If you went to a doctor who told you ‘I have no idea how this procedure works, but I was told that it works, let’s hope for the best,’ you would turn around and walk out of the office. Sure the procedure may be complicated, but you expect the doctor to have exercised all diligence in studying it out, understanding the risk, and have ‘confidence’ not hope in the outcome. I have never met a doctor who is 100% perfect in their diagnosis and remedy; rather they work in a world of probability and express a level of confidence in their diagnosis, which many of them are even willing to share with you.
Good investors are similar in that they have studied out their investment and have ‘diagnosed’ the most probable outcome. Then they continue the ‘procedure’ with a level of confidence in their decision. They recognize that the outcome carries a degree of risk and they take steps to minimize the risk. When the ‘diagnosis’ and the ‘procedure’ do not work, they turn to the next most probable ‘diagnosis.’
Good investing does not rely on luck!
The purpose of investing is to make your money work for you and make more money.
First, Use your own money. Use your own money. In the spirit of “keeping things simple” and especially in the beginning, you should use your money. There is a tendency for new investors to use OPM, that’s other people’s money. Borrowing other people’s money to invest brings a level of complexity to your objective. Borrowed money must be repaid eventually. This will increases your stress in making the correct diagnosis the first time. Imagine a doctor who is presented with an ultimatum of curing an ailment or her life! She is bound to feel an increased anxiety to make the right diagnosis. In a small way you will experience this same anxiety when borrow money to make an investment.
Second, Make your money work. Make your money work – not you. The purpose of investing is to create income from your money not your time. Many new investors will work for their money spending hours and hours analyzing and never actually invest. To “keep investing simple,” understand that just as you developed your personal skills and abilities at your job, your money will go through a similar learning curve in it’s employment. You did not learn everything you know that makes you successful at work in the classroom, in fact, your greatest skills and knowledge was probably learned “on the job.” As you make decisions with your money, you will learn. Start with the simple strategies Proform Trading teaches you and get your money to work! You will probably make mistakes just like you did when you were training for your job. Don’t sweat it! If you keep investing simple and follow the rules, you will be able to learn the skills and knowledge of successful investing and live to tell about it!
Third, Make more money. Third, make more money. To scale the ranks of investing success you must turn your investing into a system that can duplicate your success. In the beginning your success might be hit and miss. You may make money one day and lose it the next. Just like shooting free throws in basketball focus on those things that work and do them over and over again. If something doesn’t work - throw it out. Spend your time making good ideas better, and NOT making bad ideas good!
These simple rules will help you measure whether your choices are consistent with the purpose of investing.
There are two rules that govern your decisions when it comes to making money in the market: Measure success over time. There is an innate desire
in each of us to be successful – you can thank your ancestors for this instinct of survival! However, successful investing is like successful golf. Each individual stroke is important, but it is the score at the end of the game that matters. Golf measure success not in the individual stokes but in a series of strokes. The concept of par is appropriate for investing, as it may take 3 or 4 strokes before you put money in the “cup.” If your experience is anything like mine, you will discover that several attempts will end in failure, breakeven, or even a small gain before you hit a “winner.” It is helpful to keep this in mind while measuring your proficiency at investing. In fact, this is the reason why mutual funds and professional money managers only report the cumulative “success” over a quarter or year. These professionals keep their life simple by only reporting their success over time.
Make Every Investment Count. Don’t let the previous rule over-ride responsibility. Just like golf, in order to succeed, each stroke must bring you closer to the cup. You can’t slice an investment with out damaging your game. If you get off course, adjust and bring your performance back in check. The rule is to determine whether you are right or wrong every with every investment you make before the investment gets too far off course. In financial talk, this means you cut your losing investments quick and keep your winning investments. Every investment you make should include a window of time where you evaluate your decision. If the investment performs as expected during this evaluation process, keep it. If the investment does not perform, get rid of it. Simple as that. The simplicity of these three rules will ensure that you develop the characteristics of a successful investor. You will use your own money, you will make that money work for you, and you will make sure that every investment you make will bring you closer to success! Pretty simple right!
How Do You Make Money Investing? Now, let’s look at our second area of focus: How do you make money investing? If the reason we put our money to work is to make more money, we need to understand how this happens. The answer might surprise you because it’s really quite simple: buy low and sell high. Literally every investment strategy, method, concept, or technique is rooted in this concept. In keeping investing simple, don’t get hung up on the details of “how.” There are more answers to that question than there is sand in the sea and you could literally spend a lifetime studyin all the different ways to buy low and sell high. Especially when you consider how many different investment vehicles exist and their respective characteristics and circumstance. No, it’s much easier than that.
McDonalds, the trillion-burger delivery company, became a model for success in the franchise food business back in the 1950’s when Ray Kroc revolutionized a systematic approach to managing a hamburger joint. Successful investors apply the same concept of systems to manage their investments. What is an investing system? An investing system is a list of specific rules, or parameters, that determine entry and exit points for an investment. These points, known as signals, prompt the execution or completion an investment. In the world of technology, systems are designed and programmed to enable a computer to accomplish a certain task. In the world of investing, systems are designed to enable an investor to accomplish the task of making money.
Investing systems may be set up for a computer to execute or for a human to execute. Systems are not only for the technically inclined! The “Keep Investing Simple” approach to making money by investing, would be to define the system you want to use and then follow the rules of the system to accomplish your goals. The system may be your own creation or someone else’s like Proforms. Proform trading is a premier developer of investing systems. We have collected and developed many different systems to meet many different objectives. We understand that systems are used by people with varying goals, personalities, risk tolerance, etc. Some of our systems are programmed into a computer program. Others are defined for manual execution. Regardless how the system is implemented, the system is critical to keep investing simple.
There are three reasons why a system will help you keep investing simple.
First, Systems define your action. An investing system is a set of rule that controls your investing decisions. The system may be loosely defined meaning it allows for many variables, or it may be strictly defined meaning there are no variables. The important concept here is definition. Have you ever played a game of basketball where the only thing defined was the objective of putting the ball in the basket for a point? I remember many frustrating recesses with this type of game; we called it jungle ball. When the game was defined and everyone knew the rules, we had a much more enjoyable experience. This simple concept of defining your rules is as appropriate to your success investing as it is in a game of basketball.
Second, Systems are quantifiable. The second advantage to an investing system is that it provides quantifiable results. When it comes to cooking my wife and I have two very different philosophies. One is recipe focused. The other is a little more creative! I remember once, the “creative” dish was absolutely delicious – a real hit with the kids. We tried to make the dish again, but the results were unquantifiable – we couldn’t remember all the ingredients and ratios. Had there been a recipe jotted down as the meal was being created we could enjoy the dinner more than just once. Think how this applies to your investing. When your result are quantifiable, you are able to track and tweak the system to optimize your performance. Remember, investors make their money work for them and an investing system enables you to manage your money.
Third, Systems are manageable. In using an investing system you need to make sure you understand and implement the system correctly – otherwise Rule # 2 is useless. There is a need for practice and training. If you were to go work for McDonalds, you would discover that every element of the business is defined, managed and executed. If you decided that you did not like the way the “Big Mac” was put together and that it needed barbeque sauce, the manager would strongly encourage you to follow the system! When you change the system, you change the outcome. You get a Big Mac McRibs sandwich, which is not what people expect when they order a Big Mac. Every system has an expected outcome. When you tweak the system, you will get different results. You might think that tweaking is a good thing. It is a good thing when you are developing or improving a system. But when you have a system that works - get out of the way and let it work!
To keep things simple, in the beginning, if you do not like the results of your system, change systems. If you do not like the food the McDonalds system creates, change systems and check out Wendy’s. Each system produces a different outcome. If one system does not work for you, look for another. A good friend told me he would never invest in energy stocks again. He said he never makes any money in them. Digging a little, we discovered that he had been trying the same system over and over for two years with little or no success. Folks, that is insanity! If the system does not work, change it. There are plenty of systems to choose from and one of them is bound to work for you! Jack Schwager wrote a book called the “Market Wizards.” It is an excellent read into the lives of several successful investors that Jack interviewed in an attempt to discover the secret to successful investing. What you discover in Jack’s book is that each trader had a system, method, tactic, or strategy that was different from other investors - yet each was successful in their own rite! You can take comfort in this discovery knowing that it’s the system – however simple or complex – that gives you the chance to make money investing.
What is the probability of success? The final rule to keep investing simple is to ask what is the probability of success? Remember earlier we said that investing was not gambling. New investors naturally attribute probability with gambling. Gamblers are always asking what are the odds. The reason they ask this has to do with the probability of the gamble, which are at odds with success. The world of investing is a world of probability – but what industry isn’t? The insurance industry based on probability. The retail sales industry is based on probability. The healthcare industry is based on probability. You live in a world of probability. Every time you say the words, “I am safe,” or “I made it” you are acknowledging the probability that your safety was in question or you may not have made it. Very little in life is certain.
So to make investing simple, we need to understand probability and how to work with it. Probability in investing is the likelihood that a given outcome will occur. Most investors measure probability in terms of profitability, they ask the question, “What is the probability of a profitable investment?” In mathematical terms, you would answer saying, “There is a 70% probability of a profitable investment.” This means that if you applied this system 100 times then it would yield profitable results 70 times and unprofitable results 30 times. This always leads to the question of how do you know? In reality it is impossible to know the actual probability – there are simply too many variables.
Probability is measured two ways: backwards and forwards.
Backward testing. Back testing means that you simulate a system by look ‘back’ into history to see how the system would have performed. The results are tallied up and the probability is calculated. For example, you back test a simple trading system and discovered that it took a total of 10 trades last year. You would then divide the number of unprofitable trades (4) by the profitable trades (6), which would give you a 60% probability.
Forward testing. Forward testing is just the opposite of back testing. In forward testing, you simulate the system real time and tally up the results and calculate the probability. For example, you forward test a system by starting the system today and letting it run for a specific period of time. If the system generated a total of 10 investments during that time and 3 of them were losers and 7 were winners, the probability would be 70%.
Why do we introduce such complicated concepts when we are trying to keep investing simple? The reason is that as an investor, the probability of your system gives you the confidence you need to use it. Referring back to the doctor example, the doctor has confidence that if certain symptoms are present he can identify the ailment and prescribe a remedy. Whether you choose to back test or forward test a system before you use it, it doesn’t really matter. What is important is that you have confidence in your system. You should also understand that just because a system has a 70% probability, that it would not necessarily perform that way in the future. Both back and forward testing measure historical
performance, which is only an indication of what might happen in the future. Actual performance will vary. For this reason, we recommend finding and using a couple of different systems with different objectives. This way not all your eggs are in one systems basket. This concept is called diversification of strategy. When most new investor think of diversification, they think in terms of multiple investments. While diversifying your investment is a good way to reduce risk, diversifying your strategy or system is even better! In 1996, you may remember a music craze that swept the Nation by a little known group name “Los del Rio.” Perhaps you will better recognize their music as the “Macarena,” with the accompanying line-dance. This band ranks among the upper echelons of the worlds greatest one-hit wonders! When it comes to investing, you do not want to be a one-hit wonder. When it comes to diversification, it is much easier to diversify your taste in music than it is to change a financial habit. It is important in the beginning to learn a few systems that you can rely on in any market.
How’s the market? One last item relating to simplicity of success, before you walk away from this class, you need to be able to answer the question, “How’s the market?” When anyone learns that you are investing they will inevitably ask you this question – which is ultimately tied to the probability of your success. The are only three possible answers to this question: “The market is up. The market is down. Or the market is choppy.” That’s it. In order to keep things simple, don’t answer the question, “How’s the market?” as it relates to the markets performance today. Investors are not day traders. How the market performed today has no bearing on your success, remember rule number one. Don’t answer the question as it relates to the performance this week. Investors are not short-term traders. This week’s performance has little bearing on your answer.
Answer the question as it relates to the performance over the last month. If the markets are higher than they were last month say, “The markets are up.” Here is the secret sauce to successful investing and it relates to your answer to the “How is the market question.” If the markets are up, you should be “in” the market. If you answer the question saying the markets are down, you should be “out” of the market. If you answer the question the markets are choppy, you should be “preparing” to get in or out of the market. The markets are constantly moving from a state of choppy to trending to choppy to trending. In this manner, when you
describe the market as being choppy, what you are saying is that a trending market will soon begin – up or down! In answering the question, you are describing the trend of the market. There is a common investment adage that says that the “trend is your friend.” This means that you should coordinate your position with the trend of the market! That’s it – the secret sauce to keeping investing simple. By keeping your trades coordinated with your description of the market, you will ensure that you are positioned correctly when the market moves higher. It will also ensure that you are positioned to get out when the market moves lower.
One word of caution – it is easy to over analyze the market. It happens to the best of us. One reasons people over-analyze the market is that they lose perspective of their time frame and start reporting the market being down, because it was down today! Their focus zooms into the present and they forget the past, you cannot establish trends without focusing back on the past. For example, when going up a set of stairs each step moves higher than the previous. You measure the current step by the past step. If the current step is higher than the last, you are going up. If it is neither higher nor lower, you flat and watching for future changes in elevation. If the current step is lower than the previous, you are going down. This is how you measure trends. This is how you keep probability on your side. This is another way to keep investing simple!
Summary... Benjamin Graham, one of history’s greatest investors said: “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.” Investing is easy – just as Benjamin Graham put it - easier than most of you can imagine. In the beginning, don’t make it any more complicated. If most people experience even satisfactory results in the beginning, they would be happy. They would also find the discipline to build on their success through study and careful application so they can ultimately achieve superior results! Remember the three basic questions. Remember to apply these principles to any investment you make. Remember investing requires effort, both in keeping up to date with your investments and sharpening your skill and understanding. Obviously, investing is more complicated than this little
guide explains. However, this little guide will grow in value as you grow in your knowledge and understanding of investing. Because these are truths that can be applied to any investment, any strategy, any style, any market! As you become affiliated with Proform Trading, you will discover our passion for the super, our pursuit for excellence. We offer training and resources to help you every step of the way – from budgeting your current income to managing an international currency portfolio! Our education and training is the best in the industry. We hope you enjoy your experience with our company. Remember our rant...
Keep Investing Simple.
Copyright 2008. ProForm Trading, LLC. All Rights reserved. No Duplication, reproduction, or distribution is allowed without written consent.