Art of War Chapter 2 Summary explains how to understand the economy of war and how unrivaled success requires making the winning decision. This requires limiting the cost of your competition and engagements.
Translation for investors:
- Be very selective with the companies you decide to invest your hard earned capital
- Know the absolute worst outcome before you invest.
Cold Hard Truth
As an average investor, most commonly known as “retail investor” you have very little weight within the stock market. I am not by any means trying to down play the substantial nest egg you may have or plan to accrue over your lifetime but the truth is fund manager’s holdings absolutely dwarf ours. These managers literally have hundreds of millions and in some cases billions under management. In short, retail investors are fleas while fund managers are elephants. Therefore going head to head with such a formiddable opponent would be foolish. In terms of warfare…
- We are outnumbered – These huge funds typically have a handful of dedicated analysts who live and breathe their assigned companies.
- We have inferior equipment – State of the art software tools and automated trading machines allow them to capitalize on opportunities that we are likely to overlook.
- We have very little funds – As stated before these managers have a war chest of funds that make our portfolios look like a child’s piggy bank.
So what advantage do retail shareholders have? I absolutely love this question because the answer is so simple, we have the ability to move quickly! Given the proper education and tools we can leverage our knowledge significantly because we have the ability to get ahead of tidal waves. Let me explain…
As I have pointed out the stock market is dominated by these huge fund managers. These are the individuals who manage company 401k plans, mutual funds, thrift saving plans, etc. Because they manage such large amounts of capital they cannot enter and exit stock positions like a retail shareholder can in a single day, they have to spread out their purchases or sales over several months. This in turn creates huge moves in stocks which can turn into bullish or bearish trends.
What Is A Stock Trend?
The definition of a stock trend is simple, it is an established pattern of “higher highs and higher lows” for a bullish trend or “lower highs and lower lows” for a bearish trend. This may seem a little confusing at first but don’t worry we’re going to take a look at some examples here shortly. Right now I simply want you to understand that no matter how strong your conviction is in your analysis if it goes against the current trend you are very likely to lose money.
“Markets can remain irrational a lot longer than you and I can remain solvent.”
Follow the Trend
Now that we know who and what causes major trends in stocks, I am going to give you some philisophical stock advice. No matter how right or talented you are as an investor you will absolutely get crushed every time you go up against a larger opponent. PERIOD!
Case and point!
Below is a graph of the S&P 500 from January 1995 all the way through the dot com bubble which eventually busted around July 2000. During that time period stocks were astronomically overvalued and a sound investor would have stayed far away from the insanity, however they would have missed out on significant gains by exiting their positions.
Now let’s take a look at the S&P 500 during the worst financial collapse since the great depression which occurred from July 2007 to July 2009. Investors watched in agony as their portfolios took more than a 50% pay cut. During this collapse you had stocks trading at insane valuations, some stocks were trading for less than the cash they had on their books. Investors were in a panic and running for the exits, any investor worth their salt would have salivated over the values presented during this time period but allocating too much capital too soon would have resulted in heavy losses as well.
Instead of clashing with your opponent head to head, use the trend as an ally to out manuever your adversary. Let’s take a look at a real world example of trend following.
I am sure many of you are familiar with the Wall St darling Apple! I’m almost certain that the majority of you don’t need me to go into detail regarding Apple’s success over the past 5 years. If you are unfamiliar with their success it’s no biggie, it definitely doesn’t count against you, we are all here to learn. In short Apple revolutionized their company and their brand with the creation and launch of iProducts. These consisted of iPods, iPhones, Macbooks, etc during this time period the stock went from approximately $75 all the way to $700, that’s almost a 10 bagger (1000% gain)! Apple was an incredible growth story their success was truly amazing to follow over the years.
Unfortunately no company continues to grow at a rapid pace forever and in regards to stock prices what goes straight up must eventually correct and Apple is currently taking a beating and slowly approaching a loss of 50% from its peak. I personally know some investors who are starting to get interested in the current valuation of Apple, after all it is still a great company and certain technical indicators are flashing “buy.” However, if you take a look at our graph you can see the trend is currently bearish. It consists of “lower highs and lower lows” instead of “higher highs and higher lowers” necessary for a bullish trend. Investors who are contemplating buying at these levels are are going head to head with the elephants. It is much safer to identify an established bullish trend then buy instead of subjecting yourself to a larger opponent.
Do you follow bullish or bearish trends? Have you ever gone head to head with elephants? What was the outcome?