Warren Buffett, Meet Jesse Livermore

Do stocks always seem to fall after you buy them?

Do you buy cheap stocks only to sit back and see them get much cheaper?

Or, following selling a stock because it is ‘expensive’, will it continue to rise in a seemingly deliberate attempt to spite and humiliate you?

Well, this is the topic of my Facebook chat with Kris Sayce today. Hit the screenshot beneath and have a listen. And remember in order to ‘like’ it:

In today’s Money Morning I’m going to provide you with a solution to these woes. I will explain why so many people seem to make these ‘mistakes’. Don’t worry, I’ve made them too. It’s what led me to this answer.

But first, a quick comment on the latest from China. Just what is happening in the Middle Kingdom? Are the Mandarins starting to lose it?

Yesterday wasn’t a high quality one for the central planners. Credit data for the month associated with July showed that nearly 900 billion yuan in new financial loans went to ‘non-bank financial institutions’. This is cash that effectively went to support the stock market.

The data from Reuters is actually even worse:

‘China has enlisted $800 million worth of public and private money in order to prop up its wobbly stock markets, a Reuters analysis exhibits, but the impact of the unprecedented government-orchestrated rescue has so far already been modest.

‘Public statements, media reports and market data demonstrate that Beijing unleashed 5 billion yuan (515 billion pounds) in funds – equivalent to nearly 10 percent of China’s GDP in 2014 as well as greater than the 4 trillion yuan it committed in response to the global financial trouble – to calm a savage share sell-off.’

Hang on…let’s get this directly. China just blew 10% of its GDP to prop up the stock market!? In the event that true, this is crazy. No surprise money is flying out of the country.

And after that at the same time, China devalued its forex, the yuan, against the US dollar. While the devaluation was ‘only’ 2%, that is large in currency terms and the biggest move in the actual yuan against the greenback since 94′.

I’ve warned about this happening. The US dollar is in a fluff market and it’s dragging the yuan along with it. That makes China’s exports much less competitive and with the economy struggling, it doesn’t need a strong currency.

The market reaction was negative. Aussie stocks started strong yesterday but then turned down because news of the devaluation hit. Asian markets fell as well and the selling continued in Europe and the US immediately. Clearly there is concern about the state of the Chinese economy and an official devaluation hints that China’s frontrunners might be worried too.

But as far as I can tell, this was bound to happen. China’s trying to manage a bust after going through a boom. It doesn’t seem sensible that its currency should rise. Its strength is purely a result of the peg to the dollar. So it makes sense to loosen that peg a little, no?

China said the adjustment was a ‘one-off’. Which means it probably is not. If it is a sign of things to arrive, it could accelerate capital moves from China and lead to a tightening of domestic financial policy. This in turn would sluggish the economy further. That isn’t a good sequence of occasions.

Is this the ‘treadmill to hell’ that Jim Chanos said China was on? Whatever it is, the risks are clearly increasing for The far east. Its managers really need to tweak their economic knobs carefully.

This is all part of the big picture unpredictability unfolding in the world due to a busted upward monetary system. It’s not going to alter folks. In fact, it’s only going to get worse.

Which brings me to the topic: how do you invest sensibly and prudently in such an atmosphere? I used to think that ‘value investing’ was the solution. I studied Warren Buffet as well as learned to focus on things like return on equity and guide values. His valuation strategy is different to what most people believe or understand, but it’s brilliant.

But I’m no Buffett. No one is. There’s no point trying to emulate a genius. You have to find your own way. I also worked out that Buffett’s achievement has much to do with random chance, a fact that he too has acknowledged in the past.

He started investing during America’s gold economic age. An already powerhouse economy gained the ‘exorbitant privilege’ of issuing the world’s reserve forex. This was an effective tax on the rest of the world, a tax capitalised in to US stock values, all of which Buffett owned.

That’s why Buffett is so gushing in his praise for the US economy. There’s none like it in terms of range and diversity. But there is also no other that gets a free kick like the US does.

Buffett’s genius is in having the patience and the stock selecting skills to sit back as well as let the magic of adding to work. Few of us have this type of luxury.

Also, Aussie companies don’t have the same scope for development as US companies. You can’t just sit back and personal an Aussie stock for 10 or 20 years and let the development take care of itself. Our economy is too small, too narrow, as well as too cyclical.

I found myself buying stocks that I thought had been cheap…only to see them drop by another 30% or so. Value investors think this is great, and that you should buy more! However i found that ‘averaging down’ was the fatal flaw in value trading.

I also found the ‘Buffett’ worth approach hit and miss. Some stocks went on to do very well, and some stocks turned out to be duds…their high returns on equity a short term mirage.

There had to be a better way, I thought. A way of continuing to invest properly by ‘buying low’, but also protecting personally against common mistakes.

Then I read Reminiscences of a Stock Operator. Written by Edwin Lefevre, it’s a book about the experiences of Brian Livermore. Livermore was a Wall Street investor in the early 1900s. You think financial markets are volatile now! Back then there were no central banks to appease investors at the first sign of trouble.

Livermore didn’t care about value. He cared about ‘the tape’. If stocks ‘acted well’, he bought them. If they continued to ‘act well’, he bought more. A stock ‘acted well’ if it went up. Simple as that.

What Livermore was really saying was that he invested with the trend. If a stock had been going down, he got out.

After absorbing Livermore’s lessons (and having discussions with our own ‘Quant Trader’ Jason McIntosh), I began to realise further how flawed worth investing is. Buying reduced is fine, but it’s not fine to buy lower, and lower…before you run out of cash or confidence.

A strict adherence to ideals doesn’t take human feeling into account. A stock may look like good value, but if the trend is down and sentiment is actually negative, why stand in the way in which? Why not be patient, wait for the trend to exhaust itself on the downside and buy on the way support?

It sounds so simple which i can’t believe it took me such a long time to work it out.

But I guarantee you, if you go back and check out every stock you misplaced money on, it will be because you bought into a downtrend or you didn’t escape when the trend turned from bullish to bearish.

I know I’m no Buffett. And I’m not a investor in the sense that Livermore was. However by combining the lessons from all of these two disparate approaches, you are able to become a much better investor. Tomorrow, I’ll show you how…

Regards,

Greg