Successful trading is based on three Ms

Mind is your trading psychology; method is how you analyse markets; money is risk control. Would successful people who trade for a living talk about their method of making profits? The answer is `yes,' if they are talking to Dr Alexander Elder. And he comes back from his `visits to sixteen trading rooms' with enough matter to fill Entries & Exits from Wiley (www.wiley.com). "Winners know full well that success in trading does not depend on knowing the `secret'," explains Elder. "There is no secret ? only hard work, focus, attention to detail, being careful and long-term oriented with money, and having a bit of flair." Don't search, therefore, for a magic formula, which you can `buy and plug into your computer to automatically make money,' as states the intro. "Successful trading is based on three Ms ? mind, method and money," says Elder. "Mind is your trading psychology; method is how you analyse markets and make trading decisions; money is risk control." The formula is also explained as 3 Bs, viz. `balls, brain and bankroll'. These are `the legs of a three-legged stool,' because if any one is missing, you end up on the floor! Methods that work well on paper may fail when one starts trading read money, cautions the author. "When the level of emotion goes up, the level of intelligence goes down." The best way to remain calm and preserve discipline is to keep good records, he advises wannabes. "Write down your plan for the day ahead; put it next to the keyboard, and follow it. Do not change your plan during trading hours." Two pillars Elder speaks of two pillars of risk control, `the 2 per cent and the 6 per cent rules.' He elaborates: "The 2 per cent rule states that you may never risk more than 2 per cent of your account equity on any single trade." For example, if you are buying a Rs 12 share with a Rs 10 stop, you risk Rs 2 per share; and if your maximum permitted risk is Rs 2,000, you may buy up to 1,000 shares. The second pillar, that is, the 6 per cent rule states that you should never expose `over 6 per cent of your account equity to the risk of loss.' For instance, if you trade a Rs 1,00,000-account and risk Rs 1,000 on every trade, "you may not have more than six open trades at any given time." In case you lost out on two trades, you can now have not more than four open trades. "This rule allows you to have more trades when you're on a roll, but slows you down when you are starting to lose money." The first trader you'd meet in the book is Sherri Haskell. "I troll at night, looking for consolidating stocks with unusual volume," she describes her method. "Something that hasn't moved very much but has big volume ? that tells me momentum is building and it may bust out." The difficult part for her is `the discipline of not being influenced by others'. How has Sherri handled it? "I learned over time not to listen to financial programmes on TV, to reduce the number of publications I receive, and to be very careful conversing with others about the market." Elder takes us next to Fred Schutzman's trading room. "Our percentage of winning trades is about 40 per cent, and so we shoot for at least a 2:1 return, but ideally we'd like 3:1," explains Schutzman. "We are trying to get the best risk adjusted returns ? it is more game theory than technical analysis. We want to beat our competitors on a risk-adjusted basis." To succeed in the long run, take many trades, he advises. "We operate like a casino, and the law of large numbers works for us... I do the R&D, the computer pulls the trigger." Andrea Perolo, the third trader, has a simple method: "Check the weekly, discover a trend, analyse the daily to discover a good risk/reward ratio, manage it with solid money management." And his trading room is uncluttered: "Just one computer and one monitor, with no real-time quotes." Perolo tells Elder, "Trading for me is about more than money. There is no other task that is so difficult ? it is a challenge I have within myself." One useful insight he shares with the author is about fighting the feeling of arrogance. "Whenever you get a strong opinion about the market, shut down the computer and take a long walk. Your opinion is not helpful; it can influence your judgment when you look at the chart. Trade your chart, never your opinion." Three main rules Our next stop is at Sohail Rabbani's office. His three main rules of trading are: `use stops, use stops, and use stops'. Because, "you have to protect yourself if you want to survive in the markets," says Rabbani. Three Cs for success, according to him, are `concentration, clarity, and confidence.' That no one can know the future is one of his two maxims. The other is that most people are wrong most of the time. "To learn from the multitudes," therefore, "you have to see through their follies and position yourself on the other side of the trade." A book worth investing in, if your goal in trading is to become `the best professional you can be'.

The greed factor

Consider this. You decide to buy a car. You find that the price of the car that you wanted to buy has increased by Rs 25,000. What do you do? Chances are you will wait till the price comes down. Or if you need a car urgently, you might decide to buy another model that is cheaper. But what if you want to buy a stock? Suppose the stock price has gone up Rs 15 before you could buy it. If you are like many other traders/investors, you may want to buy the stock anyway. Why the difference in buying behaviour? When we see a stock perform well and also hear our friends talk about it, we become enthusiastic about owning it. That is why most uniformed investors/traders tend to buy stocks even after they move up. Of course, watching a stock move up gives us the confidence that it will move up further. And if the stock indeed does, chances are that we will attribute the success to our skills. But what if the stock instead comes down after you buy it? Chances are you will continue holding it till it moves up again. Contrast this with buying a car. You buy a car to use it. You simply postpone your consumption if you do not buy it now because the price has increased. On the other hand, if you do not buy a stock because it has just moved up and then it moves up further, you lose an opportunity to make profits. That stock price movements are readily available makes it easy for us to monitor the missed opportunity. The greed factor primarily accounts for the difference in our behaviour.

Why is technical analysis so popular?

How to distinguish `desirable, timely investments' from the rest. Let's face it: Technical analysts are gaining in popularity. Why so? Because technical analysis has `shown its usefulness through the bull and bear markets.' Secondly, it explains how the two opposing forces, viz. supply and demand, `interact to provide clues to the direction of stock prices.' A more important reason you may need to accept this is that the `technical' followers `learn how to buy near price bottoms and sell near tops.' Dejected fundamentalists may ask, "Oh, where do the rest of us go then?" Where else but to Clifford Pistolese? Because his new book Technical Analysis for the Rest of Us, from Tata McGraw-Hill (www.tatamcgrawhill.com) is about `what every investor needs to know to increase income, minimise risk, and achieve capital gains.' And the preface assures, "With a studious attitude, you can develop an enlightened approach to the market and enjoy the rewards of investing successfully." Basic concepts Begin, therefore, with `basic concepts of technical analysis' using which you can distinguish `desirable, timely investments' from the rest. "It's not possible for you to know everything that affects the financial fortunes of a company. However, all that is known about a company's prospects is reflected in a stock price chart that summarises the results of all the transactions in its stock." With simple sketches and crisp explanations, Pistolese takes you on a tour of: double and rounding tops and bottoms, up and down trends, head-and-shoulders and its inverse, ascending and descending triangles, parabolic curve and trading range, flat line formation and erratic volatility. `A note of caution' that the author hastens to add is that technical analysis can't eliminate the inherent risks in the stock market. "Consequently, when buying the stock of any individual company, no matter how well respected, it's best to limit the amount of money you invest to a small percentage of your total assets." If you are an investor who checks the prices of your stocks every day, but not the trading volumes, count yourself as `uninformed'. You're then ignoring a major factor affecting the prospects of the stocks, admonishes the author. "Watching the volume of trading and making comparisons to average trading volume enables an investor to distinguish between price moves that can develop momentum and those that are just meaningless random movements." Scores of charts pop up from the pages to arm you with line-reading skills. "A trading range is a series of price fluctuations within a delineated vertical distance," explains Pistolese in easy style. "Each trading range has its own limits, which can be narrow, wide, or anywhere in between. The top of a trading range is a resistance level, the price at which holders of the stock are eager to sell. The bottom of a trading range is a support level, the price at which investors are eager to buy." Move on to the chapter on `moving averages' where you'd learn how to smoothen out the fluctuations in the stock price. "For example, a 10-day moving average is the average of prices from the 10 most recent business days." While the `simple moving average' gives equal weight to each day's price, EMA or `exponential moving average' is more up to date because it "gives extra weight to the more recent days in the sequence." Before you start trading, Pistolese handholds you in looking for `an uptrend that is just starting, with two or three ascending bottoms', and using a ruler `to see if bottoms can be aligned to identify an uptrend.' Knowing how to trade an uptrend is an important aspect of trading, emphasises the author. "The best time to buy is after the stock price has risen a little way from the trendline. When to sell is a matter of judgment because there is no reliable way to predict where the short-term rises will end." The book has instructive chapters on portfolio management, and technical analysis and the Internet, apart from inputs on the how of analysing closed-end funds. A chapter on real estate investment trusts (REITs) speaks of the avenue as "an opportunity to make investments that pay high dividends and have the potential to produce capital gains." When real estate values are on the ascent, REITs have appeal to those looking for a balance of income flow and capital gains, explains Pistolese. "REITs write leases that last for 10 years, which makes the rental income flow more reliable." What do REITs own? Varied properties. Such as: "Health care facilities, regional malls, neighbourhood shopping centres, office buildings, apartment complexes, industrial parks, restaurant chains, self-storage facilities, amusement parks, assisted living facilities, or hotels and other types of income-producing properties... " Must read. Because if you can't beat the technical analysts, it may make eminent sense to join them!

Magical thinking

My friend's neighbour always buys shares of Reliance Industries only on Mondays. When questioned about his trading behaviour, the neighbour said that he "discovered" over a period that he got a higher return if he bought the shares on Mondays. The answer may leave you speechless. Yet, if you were to reflect on your behaviour, you might have sometimes displayed such sentiments. Have you ever worn your "lucky" shirt to your most important business meeting or to your exams, despite your mother or your wife telling you that the shirt had lived its life? There is a term to describe such behaviour. It is called magical thinking. It refers to the behaviour that leads us to believe that there is a causal effect. Consider your "lucky" shirt. You may successfully write your exams or conduct your business meeting well every time you wear that shirt. And so may conclude that the shirt is, indeed, lucky. Yet, your shirt may have nothing to do with your success. The few people who have not experienced such "magical thinking" may conclude that such behaviour is superstitious. They may be right. But as psychotherapists would agree, such behaviour can be used favourably through the power of positive thinking. How? You believe that your meeting will be successful if you wear your lucky shirt. Such belief can lead to what psychotherapists call as the power of positive thinking. That is, your positive thinking can lead to a self-fulfilling prophecy. It was, perhaps, such positive thinking that helped my friend's neighbour profit from his Monday-buys of Reliance shares.

GMR Infrastructure: Avoid [NEW IPO]

The projects in the power sector, which contribute a sizeable chunk of revenues, are dogged by low utilisations and new projects are clouded in uncertainty. Investors can avoid the initial public offer of GMR Infrastructure (GMR) for now. The offer is stiffly priced; lack of visibility in earnings growth from the current revenue model, which is dominated by power, and the risks involved in relatively new ventures such as airport and road projects, outweigh the positives of being a unique infrastructure developer. GMR develops, owns and operates infrastructure projects through a number of special purpose vehicles, some wholly-owned and others joint-ventures. The company's primary business segments are power, road and airport. The IPO proceeds of Rs 800-950 crore are to be used to fund road and airport projects and pay a promoter group company towards acquisition of GVL Investments, which holds a 9 per cent stake in Delhi International Airport Ltd (DIAL). The offer price band of Rs 210-250 is at a price earnings multiple (PEM) of 75-89 times the consolidated, fully-diluted, FY-06 earnings. While international players in the concession business such as Cintra of Spain command a PEM of close to 150, their business model cannot be directly equated to that of GMR, as the latter, even after considering the road projects on hand, would remain mainly a power generation company. Challenged by power The power and road construction businesses accounted for 83 per cent and 14 per cent respectively of sales for the year-ended March 2006. In the power segment, all the revenues are now generated by two projects ? the 220-MW Chennai power plant and the 200-MW Mangalore unit ? both of which are suffering from low utilisation because of the high tariff brought about by oil-based fuels. The current power purchase agreements (PPA) ensure that the fixed costs along with a fixed return on equity are recovered from the respective State electricity boards. However, the PPA for the Mangalore project expires in 2008 and the terms of its renewal are clouded in uncertainty.Further, the company's third power project at Vemagiri, Andhra Pradesh, based on natural gas, is unlikely to generate power in the near term for want of adequate gas supply. GAIL, the gas supplier, will supply only on "best efforts" basis as enough gas is not available in the region now to service the needs of all the customers.The picture may not improve until gas discovered in the Krishna-Godavari basin is brought to shore in the next three-four years. Given the uncertainty over the Vemagiri plant's commercial operation, the company is re-negotiating the terms of the present PPA. GMR has also planned some hydropower projects but they are long gestation ones and, hence, do not add any immediate revenue visibility. The growth prospects for the power business are, therefore, likely to remain stunted. Paving the way GMR has quickly strengthened its position in the road segment with two annuity projects and four more, which will commence operation by 2008-09. The road segment is likely to attain balance with 50 per cent of its revenues coming as they would from annuity projects. The rest would accrue from high-risk, high-return toll-based projects. GMR is, however, not a construction player and will be outsourcing much of the building work. It may, thus, lose the edge in terms of margins compared to the engineering procurement and construction (EPC) players in the field. GMR has agreed to transfer the right to receive 73 per cent and 68 per cent of the receivables from its current two annuity roads projects to a consortium of banks and financial institutions for 15 years from May 2005 against secured loans received. This means the present revenues from the road segment would not directly fill the company's coffers. The road segment is, nevertheless, likely to drive volumes on the back of the huge investment plans of the Centre and the States. Take-off yes, but... The success of the concession for the Hyderabad Airport, which is likely to be operational by August 2008, would depend on the actual traffic that the airport is able to attract. As of now, Mumbai and New Delhi remain the primary transit hubs in the country. The lease for this project, however, provides the right to develop hotels, resorts, and so on, in conjunction with the airport within the 5,500 acres of total land provided. This leaves considerable scope for commercial revenue generation, if the Hyderabad airport consortium is able to plan and develop such area. While the operation management and development agreement of the Delhi airport has commenced, the agreement is still under legal contention from one of the unsuccessful bidders. Further, about 46 per cent of the gross revenues from the Delhi airport (unlike a 4 per cent concession fee and annual lease rent on a deferred basis in the case of Hyderabad airport) would be shared with the Airport Authority of India for the entire duration of the concession. This takes the sheen away from the seemingly lucrative project. The key to ramping up revenues in airports may lie in increasing the proportion of non-aero revenues which, in turn, depend on passenger traffic. The current mix of aero-to-non-aero revenues of 70:30 in Indian airports may have to undergo a drastic change. Singapore's Changi Airport started with a 60:40 mix in 1981, but that ratio has now reversed in favour of commercial revenues. While we are positive about the potential from the airport infrastructure segment, the above issue appears to cloud the medium-term earnings visibility. The structuring of the group that involves complex cross-holdings among group companies and promoter outfits does not add to the comfort levels on the offer. Offer details: The offer will be open from July 31 to August 4. Enam and JM Morgan Stanley are among the book running lead managers. Retails investors will get a discount of 5 per cent on the issue price.

Real gains from real estate

To an investor in real estate, property is a source of income and an avenue for wealth generation, as any other business pursuit Buying property is one thing; investing in property is another. Most people buy property to get a roof over the head. To an investor in real-estate, property is a source of income and an avenue for wealth generation, as in any business pursuit. If you would, therefore, like to `become a real estate entrepreneur,' here's help from Gary W. Eldred in Trump University Real Estate 101, from Wiley (www.wiley.com). Begin with your three budgets, urges the author. The first is the mental budget, that is, "how well you allocate your thoughts, attitudes and beliefs." Next comes the money budget, the most easily understood and widely followed one. Last is the time/activity budget, or the hours you are going to devote "to looking at properties, building business relationships, and reading related books and articles." Play straight One of the early lessons that Eldred offers is, `honour your appointments, promises, and agreements.' Important because "real estate attracts more than its share of fakes, pretenders, wannabes, sharks, shirkers, and weasels." What do these people do? "They over-promise and under-deliver. They continue to push for concessions long after the deal is struck. They refuse to close contracts for slight or illegitimate reasons." A chapter titled `Make great decisions' begins with questions that can make many feel queasy: "Do you endlessly mull over `what should I do' types of questions? Do you second-guess and rehash the decisions you've made? Do you regret past decisions?" If yes, take help from Eldred to analyse your decision-making process. Five pointers from the author are: "Rank priorities, explore possibilities; get your facts straight; use rules of thumb cautiously; question advice and recommendations; and organise your thinking." Quality facts provide the ingredients for quality decisions, reminds Eldred. Before you interpret, you need to think, analyse and verify. Avoid a rush to judgment. The world overflows with GIGO (garbage in, garbage out) decision-making. But with facts, you can outperform the conventional crowd." An apt quote of Napoleon that the author cites is: "A leader has the right to be beaten but never the right to be surprised." Create your MVP (or most valued property), by searching for competitive advantages, and offering customers what they want. "Many owners of investment properties still think of themselves as `landlords' and they think of their residents merely as `renters' who don't deserve customer care," rues the author. Put yourself in the shoes of the customer to find out what improvements are looked for. You can add value by giving your property a makeover, counsels Eldred. "As you first walk into the unit, are you met with a bland neutrality? Do you see faded paint, scuff marks, outdated colour schemes, cheap hollow-core doors, nail holes in the walls, worn carpeting, torn linoleum, old-fashioned light fixtures, cracked wall switch plates, or stained sinks? If you answer yes to any or all of these questions, you've found an easy way to create value." Appreciate property Create the curb appeal, urges the author. "When prospects pull up to your property, make sure they immediately feel, `This looks like a nice place to live.'" Your building is your best advertisement, declares Eldred. For the aspiring real estate entrepreneurs, a useful clue is to carry a camera in the glove box of the car. What for? "When you see a building or yard that displays eye-catching features, snap a picture." Also, read the specialised magazines devoted to architecture and interiors, to `extend your creative thinking and aesthetic sensibilities.' The final chapter is on valuing properties. Market value is a major data point, but it should not be your sole decision guide, instructs the author. What about appraisals? "Critically examine all input data and question all inferences and conclusions," because "value conclusions are worth no more than the accuracy of the data and the quality of the reasoning that support them." One of the approaches to valuation relies is that of income, based on GRM or the gross rent multiplier. GRM formula is `sales price divided by monthly rent.' This approach leads to a rough estimate of market value, though it does not adjust for "sales or financing concessions, features, location, condition, or operating expenses." Another method is income capitalisation. Sage wisdom from Eldred is that you should never assume the experts (be they the lawyer, accountant, broker, banker, or any professional) to know enough to advise you in all areas for which you seek advice. "Question, probe, and explore issues." For, "you can't wear a blindfold in business." Exciting read on for real gains from real estate

THE ART OF AVERAGING

Of all the popular stock market concepts, there is none as credulous as the oft followed "averaging down". To put it simply, when the stock price goes down, more stock is bought at lower levels so that the average cost of the stock in the portfolio goes down. This is done with the hope that the total holding of the stock will move in to profit soon. Emotions have no role whatsoever in trading. The first thing to do when a trade goes against you is to admit that you were wrong. Secondly, stick to the stop loss and exit in time. The loss should not be allowed to grow so large that you feel tempted to average. Averaging can work sometimes. But if it does not, the pain gets exacerbated and so does the hole in your pocket. Professional traders never average down. They only average up. In other words, they add to their profitable positions, not to loss making positions. There is a method to do it, called "pyramiding". The maximum quantity is bought first. As the profit starts building up, half the original quantity is added and then half of the previous lot and so on. To elucidate, if a trader purchases 100 shares of Infosys initially, he will buy 50 more shares more as the price moves up and another 25 as the price moves up further and so on. The question arises about when exactly to add to you winning position. Those who follow charts can use moving averages, supports and resistances as levels at which to do pyramiding. Those who do not use charts can pyramid after a certain pre-determined percentage move in the right direction. It all boils down to the age-old trading maxim - cut your losses rapidly and let your profits run. So, the next time you feel tempted to average down, don't do it. Book your loss instead. Easier said than done. But then, who said trading was easy.

Market is a moving target, as in football

All work and no play makes Jack a dull boy. Ditto with all trading and no fun. Which is why it is relevant to read A Playbook for Stock Market Success from Bloomberg (www.bloomberg.com): Tom Dorsey's Trading Tips by Thomas J. Dorsey and the DWA Analysts. The `play' begins right from the blurb, thus: "In football, whether you're planning a run or a pass, you must develop the right stance. Similarly, if your portfolio doesn't have the right footing, you're less likely to beat the market." Play #1, however, is musical: "Playing the piano with two hands is better than playing it with only one." Likewise, you should combine technical with fundamental analysis, advise the authors. "Let the fundamental analyst help determine what you buy. But let the technical analyst determine when you buy that particular stock." On a musical note Learn to use, therefore, point and figure charts, a methodology that has been around for more than a century. Demand and supply show on the charts as Xs and Os, in alternate columns. "Charting by hand will allow you to see reversals take place. It will let you see patterns develop and give you the opportunity to act quickly on those patterns." The chapter on `market psychology' begins on a football ground: "When the football team steps on the field Sunday afternoon, all the players must come with a positive mental attitude, believing they are going to win." Exude confidence, exhort the authors, because that's the key to success in sports, life and investing. "The only way to gain confidence is to be prepared to control your negative thoughts." For this, first, find a discipline - "a methodology that you believe in, one that meets your risk characteristics and financial goals". Approach investment like athletes. For example, how does a basketball coach develop plays? Based on the players' talent levels and skills. "He teaches those plays every day until the team can run them in their sleep. Just because they lose a game doesn't mean they start the next practice with a new set of plays. Consistently playing your game over time simply leads to more wins than attempting new plays every week." Common mistakes Eight common investor mistakes to avoid include: Falling in love with a position; buying right but forgetting to sell right; no game-plan for investing; taking small gains but not being willing to take small losses; acting on poor advice and hype; and getting emotional. On the last one, the authors' counsel is to remember that emotion can be your worst enemy. "Try to stay objective." When looking at the chart, cover up the name of the stock, they say. That way, you can make your decision on what the chart is telling you, taking emotion out of knowing the name of the stock! Being arrogant is the first of `ten ways to sabotage your portfolio'. The market teaches humility, teach the authors. "As soon as you believe you know why the market acts, you will be proven wrong... You must be able to admit defeat and preserve enough capital to fight again." How about holding on to losing stocks with the fond hope that they would come back? Just another sabotage technique, because "hope is eternal, but your portfolio is not." Shouldn't we pursue perfection? No, please don't. Stop believing that there is a better system out there, and that you need to find it. "Using a new system to invest each week will not get you to your goal. You will become good at nothing and moderate to bad at everything." Also, there is nothing like a perfect trade. "If you only buy stocks that have all positive attributes you will maintain a portfolio of cash." Instead, "Look for the big ones like relative strength, trend, and signal... You are better off being approximately right than precisely wrong." Market is a moving target, please note. It doesn't wait around for you to catch up, so better practise. As football coach Vince Lombardi says, what you need to do is to react instinctively. "Dictionary is the only place that success comes before work. Hard work is the price we must pay for success. I think you can accomplish anything if you're willing to pay the price," is a quote of his on www.brainyquote.com. To hone your instincts, the authors advise the practice of looking at different chart patterns, and analysing what happened afterwards. Among the many tips in a chapter on stock selection is this: "Good stocks stand out in market declines." Look for the silver lining. "If you see a stock moving sideways during a market decline, it suggests there is enough demand for that stock to offset all of the supply." Play #47 explains the mathematics of losses. Limit losses, and let your winning positions run, insist the authors. "Most people do the exact opposite - they let their losses run and are trigger-happy to take the gains." Edge-of-the-seat read for the football season.

The Pike syndrome

Consider this: My friend's father bought some shares in mid-2005. His portfolio rose handsomely in just a few months. He could have made good profits had he sold his investment in early 2006. He, however, refused to sell, arguing with my friend (his son) that he would take profits after the market moved up further. Unfortunately, the market declined sharply. So, his investments instead made losses. Later, as the market moved up, he was advised to buy more shares. But because of the losses, my friend's father decided not to invest in stocks again. My friend terms his father's behaviour as the Pike Syndrome. What does that mean? Pike is a fish that has a strange habit; it eats smaller fishes. Suppose you drop smaller fishes in a glass jar and lowered the container into the water. The pike will lunge at the smaller fishes many times only to get hurt bumping against the glass jar. After sometime, if you were to drop the smaller fishes directly into the water, what do you think the pike will do? Devour its prey? Interestingly, the pike will not eat the smaller fishes. It will remember the previous incident when it bumped itself painfully against the jar. It suffers from the once-bitten-twice-shy attitude. It fails to understand that the situation is different now. From this behaviour comes the term Pike Syndrome. Karl Albrecht, a management consultant, coined this term to reflect conditioned thinking. My friend's father lost money due to his unjustified expectations. Rather than take advantage of a good buying opportunity later, he decided not to buy shares again. His behaviour is no different from the pike.

The secret behind great investments is `gutsy moves'

The masters don't gamble. "They invest deliberately and purposefully, and they outperform the average investor as a result Markets have been going down and up. If that makes you feel queasy, here is help. "You can achieve success in the stock market if you follow a set of well-defined investment principles and refuse to abandon them when the market acts irrationally," assures Scott Kays in 5 Key Lessons from Top Money Managers, from Wiley (www.wiley.com). First check if you belong to the majority in the world of investment that comprises those who want hot stock tips. "Unwilling to learn the rudiments of investing, they invest in companies because `they've been going up.' The thrill of the action is as important to them as the profits they make." To them, investing is not about maximising the returns over time. The minority are the few who study the art of investing "in a constant effort to increase their knowledge and improve their skills." Kays points out that these people take time to learn what matters when buying the stocks. "They don't gamble; they invest deliberately and purposefully, and they outperform the average investor as a result." Chapter 1, titled `The return of common sense', reminds us that many complex investment strategies only veer investors away from the crux. "What kind of pattern is the stock's price chart forming? What was the stock's relative strength last week? The masters classify these questions as irrelevant distractions." More right than wrong Great investments are about `gutsy moves,' requiring the execution of the fundamentals, using `straightforward methodologies,' even as lesser mortals look for `something flashy, something unusual, to give them an edge.' The difference is simple: "The na?ve talk of what should do well over the next few weeks; the masters consider the long term." The author devotes a chapter each to five top money managers, beginning with Andy Stephens of Artisan Mid-Cap Fund. The art of portfolio management, the way Stephens does it, is to be right more than being wrong ? at least to be right in a bigger way. "It's a trade-off between capitalising on opportunities and protecting my downside if I make a mistake," he says. Structural competitive advantage that he seeks in enterprises has four components, viz. dominant market share, proprietary asset, lowest cost structure, and defensible brand. "Firms that possess two or more of these advantages will likely perform in the upper quartiles of their industries. Because their cash flow is safeguarded, investors can value these firms with a higher level of confidence." Lessons from mother Next expert is Bill Nygren of Oakmark Select Fund, who learnt all about investing from his mother. She kept the family on a strict budget, he remembers. "A true value shopper, she visited three supermarkets each week, checking out the specials they were each running... If an item was fully priced, she bought less of it or passed on it completely." Kays notes that buying quality, undervalued-companies gets you only halfway to a successful investment experience. "Knowing when to sell a security is just as important. Fortunes have been lost because investors have tried to squeeze every penny out of winning situations and held on to positions long after they should have gotten rid of them." Sell a company when its price reaches 90 per cent of its fair valuation, Nygren advises. "Liquidate a position when a company fails to perform fundamentally as you expected. If you realise you made a mistake, the sooner you admit it and deal with it, the more likely you will minimise its impact on your performance," are further insights of immense value. No lottery tickets The third expert that Kays introduces you to is Christopher C. Davis of Selected American Shares. The foundational principle he adopts to select securities is, "Stocks are not pieces of paper like lottery tickets, but they represent ownership interests in real businesses." Once you accept that, answer the following two questions: "What kind of businesses do you want to own? And, how much should you pay for them?" According to Davis, "Businesses that grow their values at above average rates for long periods of time make the best investments." His three criteria of superior businesses are: Financial strength (as evidenced by a strong balance sheet and high returns on invested capital), competitive advantages (such as brands, patents and economies of scale), and shareholder-oriented management (with a strategic vision and a realistic plan). To assess the last criterion, that is, shareholder orientation, Davis digs deep to understand `the thought process and logic' of the company managers' capital allocation decisions. "Before he invests in a company, he ensures that managers have a strong understanding of their cost of capital and the return they expect to achieve on investments." Compound mystery Bill Fries of Thornburg Value Fund, the fourth expert you encounter in the book, recounts how his eighth-grade teacher unlocked the mystery of compound interest, and sparked his interest in saving and earning money on money! What is his investment technique? He divides his portfolio into three types, viz. basic value, consistent earners, and emerging franchisees. Fundamental research that he uses filters out for promise and discount. "A cheap stock can remain cheap indefinitely," he cautions. Identifying cheap stocks is easy; what's tough is "finding companies that can achieve a healthier than generally expected future." Two core philosophies The fifth expert is John Calamos Sr, of Calamos Growth Fund. His core philosophies are two. One, "to create wealth, you have to give up some of the upside to preserve capital on the downside." Calamos quips, "I'm long-term bullish, short-term scared, all the time." While the economy can create significant prosperity over time, "the stock market can drop unexpectedly at almost any moment," he warns. "When that happens, he wants to maintain his principal intact, even if that means missing out on some of the market's growth during the good times," explains the book. His second philosophy reads, "No strategy works very well for very long, so you have to keep evolving your process." Calamos says there is no `magic quantitative equation' that works all the time. "If such a formula existed, everyone would use it and it would no longer work. What works at any point in time constantly shifts." Compulsory read.