The 5 Magic Words Every Master Investor Says Over and Over
You can file this interview under "trading ideas you've never heard of."
The trading idea you'll read about below is something that could immediately turn a struggling trader into a highly profitable one. This idea has nothing to do with a specific stock or commodity trading system.
Instead, it's a rarely used trading exercise you can use to ensure you're always making money in the market. Sharing this secret is Brian Hunt, former Editor in Chief of Stansberry Research. Brian is a successful private trader, and oversaw one of the world's largest independent financial research firms. He previously wrote the "Market Notes" column in DailyWealth, one of the most popular daily investment advisories in the world. Read on for how to perform this valuable trading exercise...
Stansberry Research: Brian, you claim just "five magic words" are the secret to successful investing. You claim every master investor says these words over and over. Can you share those magic words?
Brian Hunt: Sure. The five magic words – and this works with real estate investing, small business investing, blue-chip stock investing, or even short-term trading – are: "How much can I lose?"
The master investor always focuses on how he can lose money on a business deal, a stock purchase, or a piece of real estate. He is always focused on risk.
Once he has the risk taken care of, he can move on to the fun stuff... making money.
Almost every new investor focuses 100% about making money. They focus exclusively on the potential upside of an investment. They're always thinking about the big gains they'll make in the next hot stock, the next big trade, or their uncle's new restaurant business.
They don't give a thought to how much they can lose if things don't work out as planned... if the best-case scenario doesn't play out. And the best-case scenario usually doesn't play out. Since the novice investor never plans for this situation, he gets killed.
Through years of investing and trading my own money – and through years of hanging out with very successful investors– I've noticed that when presented with an idea, the great investor reflexively asks early in the discussion, "How much can I lose?"
Like I say, you can ask this question about a business deal, a stock purchase, a piece of real estate, or any other investment. The number one concern should always be, "How much can I lose? What happens if the best-case scenario doesn't pan out?"
Stansberry Research: It's along the lines of Warren Buffett's famous investment rules. Rule one: Never lose money. Rule two: Never forget rule one.
Hunt: Right. Buffett is greatest investor in history. He’s worth tens of billions of dollars because of his ability to analyze investments.
When they ask the old man his secret, he doesn't talk about the intricacies of balance sheets or cash flow analysis. The first thing he recommends to folks who want to make money in the market is to not lose money in the market. That's his first rule.
Buffett is obsessed with finding out how much he could potentially lose on a stake. Once he's satisfied with that, he looks at what the upside is.
Buffett is your great investor. Now take Paul Tudor Jones, an incredible trader with a net worth in the billions. His interview in the classic book Market Wizards is one of most important thing any market participant can read. Jones’ interview is filled with how he's obsessed with not losing money... with playing defense.
Tudor is a short-term trader. But he has the same core belief system as Buffett. Tudor says his most important rule of trading is to play great defense, not offense. Tudor always focuses on the risk involved in any move he makes in the market. Once he determines the risk, then he considers the upside.
If a new investor taped Buffett's quote in a place he'd see it every day… and if he would reflexively ask himself, "How much can I lose?" before investing a penny in anything, he'd be worlds ahead of most people out there. He'd set himself up for a lifetime of wealth.
Stansberry Research: OK, that covers the theory. How can we put "How much can I lose?" into everyday practice?
Hunt: Well, if you're putting money into a startup business, a speculative stock, or anything else on the riskier end of the investment spectrum, the answer to "How much can I lose?" is usually, "Every last dollar."
While investments in new businesses and speculative stocks can be big winners, they're best played with small amounts of your overall portfolio. Or, if you're a conservative investor, not played at all.
Let's say you're buying a speculative gold-mining stock or a speculative tech company with just one potential "big hit" product.
With speculative positions, there is always the possibility that your money could evaporate. This is where the concept of position sizing comes into play.
In a speculative situation, you're going to want to put just 0.5% or just 1% of your overall portfolio into the idea. That way, if the situation works out badly, you only lose a little bit of money. You certainly don't want to put 10% or 20% of your portfolio into a speculative position. That's way too big. It’s way too dangerous.
Stansberry Research: How about advice for conservative investors?
Hunt: Conservative investors should stick to Warren Buffett-type long-term investments. They should focus on owning incredible companies with great brand names, like Johnson & Johnson or Coca-Cola. These are the safest, most stable companies in the world. Most of them pay reliable dividends.
When you buy blue chip companies at good prices, it's very hard to lose money on them. They are such incredible profit generators that their share prices eventually rise and rise.
If a conservative investor can buy a super world-dominating company like Johnson & Johnson or Coca-Cola or Intel for less than 10 times its annual cash flow, it's very hard to lose money in them. Ten times annual cash flow is often a hard floor for share prices of elite businesses. They don't go down past that.
Stansberry Research: How about the concept of "replacement cost"? Do you think that's important in the quest to not lose money?
Hunt: Yes. In 2010, I had lunch with a successful professional real-estate investor who raved about the values was finding on the east coast of Florida.
The market there was wrecked by the 2008 financial crisis. There were a lot of sellers who needed to dump right then and ask questions later... So he found tons of properties that were selling for less than the cost it would take to build the structures if they weren't there in the first place. He bought properties for less than that rock-bottom value... for less than replacement cost.
Since he focused on not losing money, and buying below replacement cost, it was easy for him to make money on his properties. Mind you, this knowledgeable professional didn’t rave about the price-appreciation potential. He raved about his downside being so well-protected.
That's the mindset the new investor needs to cultivate. He needs to realize the time to start raving is when he's found a situation where it's going to be very, very difficult for him to lose money. The upside will take care of itself.
Stansberry Research: How about when it comes to investing in natural resources like crude oil, silver, copper, and coal?
Hunt: When it comes to natural resources, it’s important to know that these sectors boom and bust like crazy.
The key to not losing money – which leads to making money – in commodity stocks is to focus your buying interest in commodities that have been blown out... that are down 60% or 80% from their high.
Find commodities that have suffered brutal bear markets. The longer the bear market, the better. This is the time that the risk has been wrung out of them.
Every commodity has what's called a "production cost." This is how much it costs to produce a given unit of that commodity. It's similar to the concept of "replacement cost."
After a big bear market in a particular commodity, you'll often find it trading for below its cost of production. Sentiment toward the asset will be so bad that nobody wants it. So producers get out of the business... and demand for that commodity increases because it is so cheap. This sows the seeds of a big bull market.
To cover your downside in commodities, focus on markets that have suffered a terrible selloff or bear market. In these situations, the answer to "How much can I lose?" is often, "Not much... It's already selling at rock-bottom levels."
You can certainly make money in commodities that have been trending higher for a long time, but the sure way to not lose money is to focus on the commodities that have absolutely been blown out.
Gold and gold stocks were a classic case of this in 2001. Gold and gold stocks were such bad investments for so long that everyone who bought in the 1980s or '90s had sold their holdings in disgust. They finally got so cheap and hated that they couldn't go any lower. Then they skyrocketed.
Stansberry Research: Good advice... Any parting shots?
Hunt: When you start out as an investor, you're as bad as you're going to get. So take superinvestor Bruce Kovner's advice and "undertrade."
Make really small investments to get the hang of things... to get the hang of handling your emotions. If you have $10,000 to get started, set aside $7,000 and invest $3,000 for the first year or so.
But even after going through a training period like this, it's tough to learn not to lose money unless you actually feel the pain of losing a lot of money. I had to touch some very hot stoves and take big losses early in my career before I learned this vital mindset.
If I am a skilled investor nowadays, it is only because I have made every boneheaded mistake you can think of and learned not to repeat it. I've learned that you can make great money in the market simply by not making stupid mistakes... by playing great defense. The new investor must focus on limiting risk. By doing that, the rewards will take care of themselves.
Stansberry Research: Winning by not losing. It works for Warren Buffett and Paul Tudor Jones… and many other master investors. Thanks for your time.
Hunt: My pleasure.
– Master investors like Warren Buffett always focus on risk, rather than reward. They know if they protect their downside, the upside will take care of itself.
– A great way to limit risk is to make sure you don't place huge bets on any one idea. This prevents your portfolio from suffer large, one-time losses when an idea doesn't go as planned.
|A Triumph of Lethargy and Sloth||There's No Secret to Investment Success… Except This One|