You’ve heard Warren Buffett say:
Rule No. 1: Never lose money.
Rule No. 2: Don’t forget rule No. 1."
Protect your capital - always and all ways!
if you lose 50% (exagerated to help with understanding)
It will take a 100% gain just to get back where you started (ie: 10k->5k = 50% loss 5k->10k = 100% gain!)
Always protect your capital by stopping losses.
Avoid having more than 5% of an investment in your portfolio to avoid a big loss with one investment. That means you keep about 20 or so stocks in your portfolio. Besides it gets challenging to closely track 30 plus stocks simultaneously.
Inspired by Buffet, here are my guidelines. I try to find stocks that:
- provide something that it seems like everyone is using.
- has a large market cap but almost more important to me is that it trades lots of options (the biggest have weekly options and lots of open interest)
- always compare with their competition - select the one of the largest of the breed - look for a good PEG ratio (ie <2)
- will most likely be here 10 years from now.
- PE ratio below the average of 15
- FPE ratio that is lower than the PE (suggests growth over the next year)
- ROE over 10
- A dividend (especially a 5 year) yeild over 1.5 and better over 2
- If there have been any problems with management, the company, their accounting etc - their score goes down drammatically.
- Avoid a fad stock - whether becuase it is being pushed by all the pundits or because it will benefit for whatever change in the market that is being touted
- I never buy a stock, I let other people pay me to think about taking their stock at a good price - I use cash secured puts. Here are my rules
- I set a target strike price for put options at less than the Fair Value (earnings per share * 15 ie a PE=15)
- I look for stocks that are near their 52 week low or at least below their 200 day and 50 day moving average
- look for a put option that is about 25-45 days out - ideally about 32 days out
- look for a return of 1% of you secured cash
- eg surrent price is $100/shr and a block is 100 shares so you want at least $10 your secured cash
- if you could do this every month (unlikely) you would get an annual return of 12% on your cash
- 1% is very easy to find… it is exactly 1/100th of the strike price. So if the strike price is 15 then you want an ask price of at least 0.15 (assuming ~30 days out)
- I find a good strike price that has a lot of open interest (current open options) - it will be more liquid, with a tight bid-ask spread, it is easier to buy back and rool up another month if you ever need to.
- always buy at least 200 shares or 2 puts. That way you can trade on one block (100 shares) in future trades and still retain a block (100 shares)
- if it doesn’t execute, oh well, you got paid for thinking about it.
- I rarely sell a stock, rather, I put up a stock secured block of 100 shares as a call option sale.
- I look for stocks that are near their 52 week high or at least above their 200 day and 50 day moving average
- I consider selling a call on block (100 shares) if its accumulated market value runs over 5% of my total account value (see above)
- I tend to favor getting rid of non-dividend (or low yield)
- I will almost always sell one block if the stock has doubled - my pricipal investment is then absolutely guarunteed
- If it doesn’t sell, oh well, you just got income for thinking about it.
What I do not do…
- never dismiss your own rules, rather, live by them
- never buy on impulse - it is OK and advisable to sleep on it. Watch a stock for months before investing.
- never use an advertisement or article on a stock as a guide, only as a reminder to re-evaluate based on your own criterea and research
- never regret criterea driven decisions. If you stuck to the rules and it failed review the rules but do not regret. Soros will say he is ok with one win out of three
- fads fail, fads fade… never invest based on a fad (widely shared enthusiasm for something)
These simple formula’s keep me conservative …