Monday, November 20, 2006

Book Review: Rule # 1

Rule #1: The Simple Strategy for Successful Investing

What Is It About?

This is one of the more unique books on investing. It is unique because it attempts to meld two styles of investing often considered at odds with each other: value investing and technical/momentum trading. The book does this by explaining: how to evaluate a company and identify its competitive advantage; how to determine what a fair price for the company is on a per share basis and determine whether a margin of safety exists; and how to apply certain technical indicators to buy and sell stocks. The author has a blog which provides further detail on many concepts discussed in the book.

What Did I Get Out Of It As A New Investor?

This is a good book for a new investor. The book adequately introduces the core concepts of value investing. The book also does a good job explaining the margin of safety concept. The book’s value is not found in the originality of the above subject matter; rather, value is added because the book provides a more accessible way for people to understand the concepts found in the original works.

The book also provides an introduction in the use of technical indicators. The author believes that three different indicators (stochastic, MACD, and moving averages) assist in determine the future direction of any price movement. The reliance on the specified indicators is based on the theory that the selected indicators offer a “tell” when large institutional buyers are accumulating or distribution a particular stock. Therefore, the use of indicators is not advocated as a means to determine whether you should buy a stock, the author clearly argues that it is “value” investing which aids in that process. Rather, the indicators are a means to determine when large investors are making a move and to get in, and more importantly, out of a position to avoid significant loss of capital.

It is important to note that in reading this book a new investor must resist the temptation to gloss over the more demanding parts (understanding and learning how to perform a thorough and intellectually honest analysis to find a great business selling at a discount) to focus quickly on the technical indicators. Following a certain buy or sell signal without determining whether the company is worth owing in the first place can lead a new investor to suffer a loss of capital. Additionally, by conducting the initial fundamental analysis to insure a margin of safety, the investor adds a layer of protection if the use of the technical indicators goes awry.

The Good News

This is a good introductory book which helps a new investor or trader identify a great business; how to do a discounted cash flow analysis; and explain how technical indicators may be used to make gains and avoid losses.

The Bad News

I think the book over simplifies the process of identifying a great business by ignoring the fallibility of multi-year future projections and relying too much on a companies past performance. The book also over simplifies the dangers in using technical indicators.

The Bottom Line

The material covered in this book is a good starting point for any new investor, but it is just that, a starting point. The book is worthy of reading because it exposes a new investor or trader to the idea that one should be open and flexible enough to accept that success in the stock market can come from a myriad of different techniques.

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