The Only Rule of Trading

Here is the Only Rule of Trading, the one rule you must follow in order to succeed as a trader. It's so simple, so trivial, and so trite, you may be tempted to stop reading right here, but hear me out. Rule One, the one and only rule, is very simple:

Buy Low, Sell High.

Yes, these four words completely summarize everything you need to know about trading. This is the only way you can make money. There is no other. All the charts, technicals, fundamentals, news, and rumors boil down to is that you must be able to tell when a stock is low enough to be worth buying, and high enough to think about selling.

So if it's that simple, why is it so hard to make money in the market? I think there's an evolutionary reason for this. You can see how animals in the wild band together to form herds for protection from predators. Ships crossing the Atlantic in World War II formed convoys for mutual protection. There is a survival advantage to doing what others do, being where others are. It's an instinct. Unfortunately, in trading this instinct can kill you. It's what leads people to pile on to a stock that's been going up and up, one that everyone wants to own. It looks like a sure thing and everyone's doing it. Unfortunately, unless you're early on the bus, you generally end up holding the bag.

It works the same way on the down side. When everyone is bailing out and running for the exits, you want to do that too, just like a herd of zebras fleeing a hungry lion. But this instinct can lead you to sell at exactly the wrong time - ask me how I know.

It's really hard to view down days in the market as buying opportunities, and up days as selling opportunities. Your natural instinct is just the opposite. You want to join the crowd and buy when everyone else is buying, or sell when everyone else is selling. But that's almost always the wrong thing to do. I can tell you that I've made a lot more money since I converted to contrarianism than I used to when I tried to be in with the in crowd. Buy when your stock is down, not when it's rocketing skywards. Sell when it's topping, not when it's cratering.

Of course, obviously this doesn't apply if you own an Enron, GM, or other fatally flawed stock. Unless your holding time is on the order of a few hours or less, make sure your stock has some basis in reality before even thinking of buying into it.