Rule investing, the way the best investors in the stock market succeed. By following a proven rule investing process, you have a much better chance to become a successful investor. You should develop a set of investing rules that meet your investing style. Here is the rule investing process I use to beat the market and make money every year, especially in the Premium Portfolios.

In the October 1989 issue of Futures, Dennis Gartman published his version of rule investing. Dennis is a successful trader, having experienced the gamut of trading from winning big to almost losing everything. Currently, he publishes The Gartman Letter, a daily publication for experienced investors and institutions. I mention this to show how important it is to a well thought rule investing process. When you develop your rule investing process, consider you own personality. Then be disciplined and follow each rule religiously.

1. In a bull market, only be long. In a bear market, only be short.

Approximately 60% of a stock’s move is based on the overall move of the market. So go with the trend when investing or trading. Investing with the trend is perhaps the easiest investing rule to employ.

2.  Buy what is showing the most strength; sell what is showing the most weakness.

The idea behind this rule of investing is not to buy low and sell high, but to buy high and sell higher. We never know what the low price is, or what the high price is. By buying strength we greatly improve our probability of success. Shorting on weakness works the same way.

3. Do not trade until the fundamentals and the technicals agree.

In the Beat the Market section of this site, we describe how to use fundamental and technical analysis to assess your investing opportunities. This rule investing process provides the tools to tell when fundamentals and technicals are in alignment.

4. Do not enter a trade until it has been thought out, including your target price and your stop loss price.

Before entering a trade, identify the entry price, 1st and 2nd target prices, the stop loss, the risk-reward ratio, current volume as a percent of the 50 day average, the technical pattern, the market trend, the sector, the key fundamental factors, the capital to put at risk, why make the trade and the risks that may be encountered while the trade is open. This step in the rule investing process helps to ensure I have thought out the trade before I execute the trade.

5. Only add to trades on minor corrections to support levels that go against the major trend.

Use the technical chart to identify the support and resistance levels in different time frames. Monitor volume expansion and contraction during these pull backs. On pull backs with lower volume followed by a pick up in volume, as the price rebounds is an indicator to add to the position.

6. Be patient with good opportunities. If you miss an entry trade, wait until a correction occurs before entering.

Often the price will return to its breakout point, so you do not have to chase the price. Your technical charts show support and resistance levels to help identify good entry points. As with many investing rules, use expansion and contraction of volume as an indication of buying interest. If volume expands when the price rises, it is a good sign there is more interest from buyers.

7. Be patient with good positions. Once a trade is entered, give it time to develop.

Set your targets and stops and then let it perform. As the price moves up toward your first target, move the stop up to the next clear support level. When your first target is hit, sell according to your plan and the market (1/2 of your position in a bull market, 3/4 of your position in a flat market). This creates capital for further investments and trades. Adjust your stops up to new support levels. Review your 2nd target and adjust if strength continues. The real money is made by letting your best positions to continue to perform. Taking small profits unnecessarily will not create wealth and most likely will lead to ultimate loss.

8. This can be one of the most important rules of investing. Be impatient with losing positions. Small losses are the best losses.

Following the rule investing process helps you to minimize losses. You use up too much time, money and mental capital sitting on a losing trade. Holding on to losing positions cost measurable sums of actual capital, but it cost immeasurable sums of mental capital. Of the two types of capital, mental is the most important. Besides there are always new opportunities to focus your valuable time and capital.

9. Never add to a losing position, ever.

While this investing rule is counter to an often followed belief of traders and investors, it is critical to your ongoing trading success. Many investment advisors recommend averaging down to get a better average price on a stock. Adding to a losing position or averaging down on a bad trade will take you out of the investing business very quickly.

Let’s look at what happens when you “average down” on a losing stock. When you add to a stock that is declining, your net worth declines as well. If you increase your short position in a stock that is rising, you will experience the same decline in net worth. Sure, it may prove fortunate if the stock returns to its previous levels, but in the mean time you have spent your precious capital (financial and mental) waiting and watching for it to turn around. Moreover, there is a reason the stock price is declining and you likely missed it while doing your homework.

10. Do more of what is working and do less of what isn’t.

Each day look at your positions and try to add to those that that exhibit the most strength while subtracting or eliminating those that are showing weakness. While “letting your profits run” is an interesting concept, you really want to try to maximize your profits with your strongest positions.

11. When trading well, trade somewhat larger positions. When trading poorly, take time off for a few days, closing all positions.

Align the size of your positions with your performance, making the most of when things are going well and minimizing your losses when things are going badly. When times are good, even trades based on bad analysis will work. When times are bad, even the best analyzed trades will go wrong. This is the nature of the market. Accept it.

12. Rule investing tells us to act like a mercenary fighter who invests and trades on the winning side.

Fight on the winning side and be willing to change sides readily when the other side has gained the upper hand. Invest and trade on the winning side. If no side is winning then you do not need to trade. The facts of the situation can and do change, so you must be willing to change as well.

13. When investing and trading in the markets, rule investing tells us an understanding of mass psychology is often more important than an understanding of economics.

Markets are made up of all the insight and ignorance of the people who participate. Mass psychology often rules the day, week and month. Markets can remain illogical longer than you can remain solvent according to Dr. A. Gary Shilling. Look at all the bubbles that have occurred. They each grew to extremely high levels before economics finally took over.

14. Keep your technical systems simple.

Complexity breeds confusion. Simplicity breeds elegance. Decisions need to be made with a clear understand of the factors. Simplicity also makes errors stand out so they can be easily corrected.

15. There is never one cockroach.

When you encounter a problem due to management malfeasance then expect many more to follow. Bad news begets bad news. Should you encounter any hint of this kind of problem, then avoid the stock and sell any you currently own.

Your rule investing process should fit your personal situation. Investors who expect to own a stock for several years will have different rules than one who trades every day. Moreover, adjust your investing rules as you gain experience with them. And never make a trade without following your rule investing process.

Much of our success in beating the market every year comes from following our investing rules without fail. Request a free four-week trial to our Premium Membership. You have nothing to lose and a lot to gain. While we cannot guarantee you will make money, we have beat the market every year since our inception in 2006.

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