There are no rules to stock picking, only results.
However it would be nice to have some rule to guide us.
Here are ten culled from life and science that will help you.
1 The law of 72
Take a yearly percentage profit on your portfolio and divide it into 72. You get the number of years it takes to double your money. This means at 24% a year you would double your portfolio ever 3 years. This means in 9 years you have increased your money 8 times. In 30 years your $10,000 portfolio id $1m.
This is how Mr Buffett got to be the richest man in the world.
However compounding feel remote. Using the Law of 72 you can bring it front and central in your mind. Even though Einstein most likely didn’t say it, compounding really is a great discovery.
2 Murphy’s Law
The best way to lose money in the market is to forget risk. That’s not just investment risk, it’s the execution risk of the company you are backing. The real world does belong to Murphey, there is no frictionless business even if Bill Gates wrote a book saying it would arrive real soon.
It is Murphy’s law that sinks all those crazy growth companies and scuppers all those gold mines in Africa.
If you don’t take Murphy’s law into account you’ll never understand why great ideas don’t turn almost immediately into great companies.
3. Campbells law. Goodhart’s law.
Campbell’s and Goodhart’s laws are similar. In a nutshell they suggest that any benchmark is soon corrupted and not to be trusted. Whether it’s a P/E or GDP or Libor. Numbers meant to guide are quickly cheated, gamed and manipulated to mislead the very people they are meant to guide. Take all numbers whether they are the inflation rate or a stock index with a pinch of salt.
4. Moore’s law
Not all laws are cynical and a bit down beat. Moore’s law might just be the single driver of the last 40 years of economic growth. Originally about the amount of transistor’s on a piece of silicon and how that number would grow by doubling every couple of years, it now represents the idea that technology and with it humanity will progress exponentially. Moore’s law is about abundance. People including myself on occasion, say this wonderful cornucopia must die, but apparently Moore’s Law at least as far as transistors on silicon is concerned has years more life in it. If true all you need is to go long tech and sit tight.
5. Metcalfe’s law
Yet another utopian tech law Metcalf’s law says the value of a network rises dramatically with the number of its users. 10 users = 100 units of umph, 1000 equals a million units. You could say Metcalfe wasn’t familiar with internet trolls but on the other hand while Facebook isn’t worth a gazillion more than much small sites, Metcalfe’s idea of a massive valuation for big fat networks kind of map in the valuations of Web 2.0 companies. Even if Metcalfe was wrong about his exponent, his idea still means any stock with a network effect are worth serious consideration.
6. Dunning-Kruger law.
Dunning-Kruger’s law/effect says that incompetent people think they rock at what they do. Meanwhile the highly skilled have doubt because they know things can get tricky. This tells the investor to be wary of overconfident advice and pay attention to less bullish people who appear wracked with doubt. This law does not of course apply to anyone writing for Forbes, but that’s just obvious.
7. Gresham’s law.
Good money drives out bad. While this originally applied to debased coinage driving good gold out of common usage, but it can also apply the bad driving out the good. For example shady business practises drive good practices out of business. As such you should always run “Gresham Law” over your financial service providers, because sometimes new and improved isn’t better.
8. Hofstadter’s
Things always take longer than you expect even if you take this law into account. This is very important if you are a new tech investor. The next big thing is now, is more likely to be in ten years. This also applies to speculations that seem obvious. Think that a stock will rally soon because of some obvious development? You are wrong.
It is going to take months for what is obvious to you to be obvious to the market. In market speak, “you can’t time the market,” but in experience things never happen faster than you expect. Things just take more time than appears possible.
9. Poisson’s Law of large numbers.
OK so I need 50 comments at the bottom of this article telling me in complicated maths that I completely misunderstand this law. Apologies now.
As far as trading goes I see it like this. You can trade a million times and if you don’t have a non-random reason why you trade on aggregate, you will not make or lose money, if you discount your trading costs.
You can come up with all kinds of mad indicators, astrological predictions, moon cycles and sun spots or get your parrot to make your stock picks but your net result (ignoring costs) will be no gain or loss. As such if you want to know if you are investing at random, just ad up your trading costs and match them to your losses. If they are roughly the same you are trading randomly and unless you are enjoying the process a lot, you should stop.
10. Sturgeon’s law
Sturgeon Law states that 90% of everything is crap, or rather “crud” if you prefer.
This of course goes for stocks too.
Let’s say there are roughly 15000 US stocks. That means on a quality basis, only 1500 qualify for your portfolio. That’s a pretty good universe to select from but that does mean you need to discard most shares you ever look at to the junk pile. This can be tough, you need grit and determination to sift all that garbage to find the gold.
Of course there are ten laws in this article and Sturgeon’s Law suggest there is only this one you really need to pay attention. Unless of course it is wrong.