Insider Tip: Investment Formulas

by David Jenyns on November 7, 2007

The difficulties of building a fortune using the stock market are a painfully familiar subject to the large majority of those who have tried it. The gap between the apparent ease of beating the system and actual results of investors both professional and amateur is the principal justification for developing investment formulas.

An investment formula is, in essence, a device which, taking its cues from developments outside the individual investor’s field of judgment, caprice or personal opinion, dictates a definite investment policy at all times. It does not select stocks, but it does indicate whether a particular time is favorable for owning stocks, and if so, in what quantities, and how much of an investor’s capital should be reserved for later stock purchases at more favorable levels. And because the investor himself selects his own formula and builds into it a degree of risk consonant with his investment objectives and willingness to take risks, the instructions of the formula are always in line with the investor’s own goals.

A formula’s primary purpose is to provide a degree of protection against losses caused by unforeseen market swings, and in fact use these swings as an integral part of their operation, by dictating sales of stock (or reduced purchases) as the market nears a top, and increased purchases when it bounces along a low point.

Many investors, when told the market is “too high,” might well want to ask: “Too high for what?” The formula tells them and defines investment action (or lack of it) in terms of their own portfolios and investment objectives. In addition, it has built-in safeguards against the indecision that tends to afflict almost every investor at some time, the temptation to become over-reckless or over-conservative, and even the imperfections of the formula itself.

The primary objective of a formula is to place the investor in a permanent and continuous profit position. It is gauged to produce profits over a period of time whatever happens in the market. When stock prices rise, his portfolio shows a profit. When they fall, he steps up his purchases at bargain levels. At intermediate points, he relies on the indications given by the formula ‘to continuously strengthen his profit position. One of the earliest investigators in the field of formula investing drew an analogy with a “thermostatic control,” which, like any other thermostatic control works automatically at all times without asking the investor to use his own judgment.

From this description, it may seem that formulas are nothing but an elaborate extension of the time-honored advice to “buy low and sell high.” This is, in fact, the case. The special feature of the formula method is that it tells the investor exactly what to do at all times without attempting a precise prediction of market prices. Implicit in the formula idea is that it is not possible to pinpoint every turn in the market or to gain maximum profits during every market swing. Formulas make no attempt to do this, but are aimed at putting the investor in a position to profit to some extent from any market upswing, and to provide some protection during every decline.

In the end, a formula gives an investor a way to keep his emotions in check while still making profits and taking only modest losses. The most important aspect of the formula might be its ability to instill some much-needed perspective into a panicked investor’s off-day.

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