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Over the past few weeks we discussed market analysis techniques. In particular, we examined:
- Indicators (e.g. moving average, trendlines)
- Price Patterns (e.g. price breakout, trends)
- Market Analysis (e.g. breadth, relative strength)
All this knowledge is important. But they are insufficient for you to generate wealth from investing. To successfully investment, there is a cardinal rule you must do: Investment Planning.
What is investment planning? In a nutshell, it is about creating a series of personal rules on capital allocation. And why is this important? Because without these ‘rules’, you will not have financial discipline. More likely than not, you will be ‘lost’ in the financial jungle and be parted from your hard-earned cash (fairly quickly). Billionaire investor Warren Buffett did not become fabulously wealthy by investing haphazardly. He has a lot of rules about how he invests his money – and he follows them strictly. So should you.
The first thing about investment planning is knowing yourself. It is not about markets, economic cycles, or indicators. It is about understanding your own strengths and weaknesses. For example, the first thing Jim Rogers, the legendary investor, admits is that he is utterly ‘hopeless’ in short-term trading. So he focussed all his energy towards long-term investments – with huge success.
Do you like short-term trading or long-term investing? Do you have some (above average) skills that you can exploit to earn investment returns? Are you knowledgeable about investment vehicles (stocks, foreign stocks, REITS, ETFs, Investment Trusts, Gilts, FX rates, etc)? Do you require investment advice or can you do it alone? Do you have time to follow markets – day in, day out? Have you had any experience bull and bear markets? Have you got any idea how market cycles behave? Can you tolerate (low, moderate, or high) price swings in your portfolio? Can you read a balance sheet well? What about economic indicators, are they your forte?
In a two-column paper, answer the above questions as honestly as you can. If you are not, you will have difficulties following your plan later. If you think you’re not really good or knowledgeable about investing, hire some experts to do it for you. Alternatively, you can learn to do it yourself.
Next, establish what you want from your investments. But be realistic about two things. One is your expected investment returns. Two is your current cash flow. The latter is tied to your personal circumstances, such as income level, current expenditure, and unexpected expenses. Why is cash flow so important? Because you can plan towards establishing a reservoir of firepower. Why is this additional firepower important? So that you can buy stocks when they trade at bargain price levels. This is the key to investment success.
‘Buy low, sell high‘ is an age-old motto. But if you have no money to buy when prices are low, then you will accumulate wealth at a far slower pace. Compare these two investors, Sam and John, who both started out in 2007 with $10,000. During the year, Sam saved another $5,000 in cash whilst John immediately bought more stocks with the same amount. Market crashed the following year. Sam used the $5,000 to buy stocks are far lower price levels whilst John watched helplessly on the sideline. Fast forward to now. Whose portfolio is larger? And, guess what did Warren Buffett frantically do in 2008?
Once you have determined your assets (knowledge + capital), you can then set basic investment strategies to pursue your objectives. This includes:
- What type of securities to buy and hold (stocks, REITS, ETFs, Gilts etc)
- How to buy (entry rules and signals)
- How to sell (sell rules and signals)
- Establishing pain levels (stop losses)
- Setting your diversification rules
- Setting your leverage rules
- Building a reserve fund to acquire securities during market panics
The last point worth stressing concerns compounding. Great investors make their capital do the work for them. ‘Making money whilst snoring’ so to speak. To prevent a break in the compounding cycle, invest capital that you should be able leave aside for years. If you consume this seed capital halfway, it would not grow to a big tree.
This week we take a break from market analysis and focus on investment planning. The three pillars of planning are (1) understanding yourself, (2) establishing your objectives and risk preferences, and (3) implementing your investment rules.
If you skip (1) and (2) and then adopt someone else’s plan it would not work. Because you will find it hard to follow the rules and signals because the plan is incompatible to you.
‘What then?’ you may ask. ‘After drawing up a plan, will I achieve investment success?’ Well, nothing is 100% guaranteed in life – especially on investments. But if you don’t have an investment plan, you’re more than likely to end up in places where you don’t want to be. With a map, you will at least have a fighting chance to reach your destination.
Ten things to understand before you start trading…
1. How to use support and resistance levels in trading
2. Using Moving Averages Effectively – Part 1
2.5 Using Moving Averages Effectively – Part 2
3. Momentum indicators and trends change
4. Understanding Price Breakouts and its Significance
5. Q&A On Price Patterns With Jackson Wong PhD
6. The Importance of Group Analysis
7. Three Chart Characteristics That Precede A Trend Change
8. Thoughts on trading the market via Breadth
9. Six Market Trends To Look For Outside Individual Price Action
10. The Key To Long-Term Investment Success – Know Yourself…
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Jackson has over 15 years experience as a financial analyst. Previously a director of Stockcube Research as head of Investors Intelligence providing market timing advice and research to some of the world largest institutions and hedge funds.
Expertise: Global macroeconomic investment strategy, statistical backtesting, asset allocation, and cross-asset research.
Jackson has a PhD in Finance from Durham University.