Wall Street's Rules: Breaking Them and Winning: Part 1

NEW YORK (TheStreet) -- If you are an investor in today's market and don't find yourself in a state of perpetual worry, then you are not paying attention.

I say this because I am now seeing evidence that we have entered an environment where it is acceptable for stocks to trade on a basis that is not predicated on a company's fundamentals alone. Examples include Facebook ( FB) and Salesforce.com ( CRM). This serves to remind investors that the rules are changing. If not, they are certainly being made up as we go along.

In these situations I have found that it is often best to appreciate that investing is like your favorite sport. As such it requires exceptional conditioning not only of the body, but also of the mind, as you would expect from your favorite athlete.

But also as in any sporting event, the best athletes or the ones who often come out on top are those who know the rules. Notice I didn't write "play by the rules." What these means is that understanding your environment is as equally as important as understanding your body and how much punishment and stress it can absorb.

As in sports, today's winners can easily be tomorrow's has-beens, with the only difference being the change in weather. Research in Motion ( RIMM) is the perfect example. When enterprises were soaring, RIM was a great investment play.

Today, however, consumer interests dominate device sales, which makes consumer-focused companies such as Apple ( AAPL) and Google ( GOOG) kings of the hill.

As a result, what we are also noticing is a changing of the guard where once-dominant enterprise players such as Microsoft ( MSFT) have started to shift its attention to a model that allows it to better control customer engagement -- a strategy which I think is brilliant, though it is much to the dismay of its partners.

Be that as it may, just as it is within Microsoft's right to adjust, It is also the investor's right to adjust his or her own expectations. In essence, since there has been a fundamental change in a company's model or strategy, as such it justifies a change in investor expectations. This is something I've recently highlighted in my article These Stocks Will Make Me 'Rich' in 6 Months, where the idea is that investors should constantly re-evaluate their positions to ensure their objectives are still being met and are not falling victim to unexpected market shifts as being witnessed by Research in Motion.

Highlighting this suggestion was a quote by Warren Buffett that reminds us:

"Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks."

Although this breaks one of Mr. Buffett's rules of investing, which is "to not lose," the principle in that message is that sometimes even the captain of the ship has to worry about his own survival. At some point it is better for investors to just cut his or her losses and move on to more prosperous companies.

But a reader named RadarTheKat didn't see it that way. Not only did he disagree, but appeared offended that I referenced Buffett to suggest that investors reshuffle their portfolios. In his opposing view, he offered this:

Investing is a commitment to holding a reasonably priced security as long as its underlying fundamental and business model remains attractive.  A true investment does not have a six-month time frame.

While RadarTheKat is not entirely wrong in his overall "definition of investing," it is obvious that he has made a lot of assumptions -- not the least of which is that he has chosen to define what the words "commitment," "reasonable" and "attractive" should mean in anyone's portfolio.

But more noteworthy was how he seemed to have embraced what I now consider the "old rules of investing" -- or the pre- E*Trade ( ETFC) era. He said "a true investment does not have a six month time frame." Really? Says who? What the reader forgets in the process is that the financial market is a "bottom line" business and the objective is to make money not to define your "investor status."

Then he added the following:

Your advice to re-evaluate every six months, without providing any basis for evaluation, and without suggesting that said evaluation might imply that the investor should purchase more shares of the businesses in which they are already invested.  

It seems that RadarTheKat was upset about my sell recommendation on Research in Motion. His quote above, which touches upon another Wall Street rule of "averaging down" by purchasing more shares, has done a lot more harm to investors who are often caught wanting to be right, even if it means trying to patch a leaky boat.

This is where the challenge comes in. He does not realize that he is only making the situation worse by making the mistake of following "investing rules" or in some cases myths that often lead to nowhere but to more losses, many of which novice investors swear by today thinking they are beating the market.

Because with every strategy that calls for "averaging down" on a stock, there is the opposite premise of "never adding to a losing position." As much as I hear about the importance of "due diligence," there are those who believe in "going out on faith."

Then there's the constant reminder of "invest in what you know" that is often followed with the proverbial "don't put all your eggs in one basket." In these situations, knowing exactly what methods to use can be a tricky proposition, especially if you are a young investor. It can be a bit confusing once you realize the fact that these rules (while fundamental in nature) are often direct contradictions of one another.

Bottom Line

What it means is that sometimes one has to be willing to look beyond talk and instead assess their investments based on performance and results. Nevertheless, it begs the question, where does it leave investors such as RadarTheKat who appear to not speak the "bottom line" language, especially when there isn't a translator around?

In Part 2 of this article we will look more closely at five investing rules and translate them in ways they can turn your portfolio into a winner.

At the time of publication, the author was long AAPL and held no positions in any of the stocks mentioned, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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