“Don’t Fight the Fed” is a rule that we have all heard numerous times in our careers. It is the rule for which Dr. Martin Zweig is most famous. However, Dr. Marty had 16 other rules that he developed in this illustrious tenure as a money manager. According to Mark Hulbert, Zweig “brought a rigorously empirical and scientific approach to beating the market, which, surprisingly, was not the norm among advisers when he began his career.”

This appeals to the way we view the investment world at Potomac. I am not going to do a deep dive on Marty. That has been done numerous times. Instead, I am going to take each of his 17 rules and provide my interpretation of them.

1. The trend is your friend, do not fight the tape.

The simplicity of this rule is the reason that many investors ignore it. Many people feel that it is not intellectual enough to simply follow price trends. The fundamental CFAs often mock the trend following CMTs with jokes like “number go up bro!” as if they are above it. But the profits that you make from trend-following are real. It is more intellectual to understand that PRICE (not the balance sheet, not the income statement, not the cash flow statement) is the ONLY thing that pays you.

2. Let profits run, take losses quickly.

This is another simple concept that many investors fail to grasp. Taking a loss is an admission of failure, of being wrong and, as humans, we hate being wrong. Think about how hard it is to apologize to another person. Taking a profit feels good, it makes us feel smart. As humans, we like that; it means we are winners. Therefore, the tendency is to take a lot of small wins (to feel smart) and keep losing trades for a long time (it is not a loss if you do not sell it, right?).

3. If you buy for a reason, and for that reason if discounted or no longer valid, then sell!

When the facts change, change your mind. Unfortunately, narrative-based investors often become too entrenched in their views. This year gives us a great example of this. They entered the year with a bearish view based on the inverted yield curve, slowing economic growth, and a Federal Reserve that was still raising rates. As the market went higher, these investors remained bearish because breadth was bad, only seven stocks were leading the market higher. As this thesis was debunked by broader participation, the bears have now concluded that the rally is not sustainable because it has been driven by multiple expansions. Beware of “thesis shifting” on your part and on the part of those you follow.

4. If the values do not make sense, then do not participate. (2+2=4)

This rule is geared for the fundamental crowd. My only pushback here is that “value” is subjective. As such, an analyst can twist numbers to make a compelling case on any stock.

5. The cheap gets cheaper, the dear gets dearer.

This is another way of saying stay with the trend, in my view. Also, blindly buying stocks because they are “cheap” on some value metric makes almost no sense. Likewise, rejecting a stock simply because it is “expensive” also makes little sense. Cheap stocks are often cheap for a reason. Expensive stocks are usually expensive for a reason. You can spend time digging for those reasons, or you can simply follow the price trends.

6. Do not fight the FED (less valid than #1).

The rule for which Dr. Marty is best known. Interesting that it is not #1. The Federal Reserve controls the ebb and flow of liquidity in the market. More liquidity usually equates to greater demand for stocks. The opposite is often true as well. But note that even Marty admits that rule #1 is more important. At Potomac, we incorporate both rules into composite models. Those who have been following in 2023 know that our long-term trend model became bullish in January (Rule #1). However, the ”Don’t Fight the Fed” rule has made it hard to stay fully invested for extended periods of time.

7. Every indicator eventually bites the dust.

You must always test your systems and indicators. You should always be looking for new ideas that can add value. At Potomac, we use a metric called max drawdown. If any indicator that we use violates its max drawdown, we immediately begin to reevaluate.

8. Adapt to change.

This is a good rule for life, in general, not just investing.

9. Do not let your opinion of what should happen bias your trading strategy.

This is another rule that many have a challenging time following. We all have opinions; the market does not care. I have had my worst trades (as a discretionary trader) when I have formulated some elaborate opinion on why the market was wrong. THE MARKET DOES NOT CARE ABOUT YOUR OPINION. The problem with having a strong opinion (especially if you have expressed it publicly) is that changing your mind is to admit being wrong (see Rules 2 & 3).

10. Do not blame your mistakes on the market.

Take accountability. At the end of the day, you are the key decision-maker.

11. Do not play all the time.

“Timing” the market is better than “Time In” the market. I know this will upset the passive buy-and-hold crowd.

12. The market is not efficient but is still tough to beat.

I agree with this and push back on the Nobel Prize-winning Efficient Market Hypothesis. However, I believe that the market is extremely efficient, just not completely efficient. It is in the small gap between extremely and complete that active managers go to war with Mr. Market. Ask yourself, do you really want to take on that battle with subjective ideas like valuation and entrenched narratives? I prefer a systematic, rules-based approach with a focus on price trends.

13. You’ll never know all the answers.

The best that you can do is have a solid framework for generating probabilities. If you wait for perfect information, you will likely spend much of your time on the sidelines seeing your hard-earned money succumb to inflation.

14. If you can’t sleep at night, reduce your positions or get out.

Many investors think that they can handle risk when you ask them to fill out a questionnaire. But the true test comes when their capital is put to work. If they are tossing and turning at the sign of the first drawdown, then they are not capable of handling their current level of risk. That’s fine; we are all different.

15. Do not put too much faith in the “experts.”

I love this rule, and technically we are experts. However, this applies more to newsletter writers and even sell-side research analysts. Remember, all investors have different goals and risk profiles. These are usually different from those of the experts. Do your own homework. If you cannot do the work, there are plenty of licensed professionals who can add value.

16. Do not focus too much on short-term information flows.

Learn to decipher signals from noise. We live in a 24/7 soundbite world. The best investors have the best filters.

17. Beware of “New Era” thinking, i.e., it is different this time because…

I started my career at the absolute top of the dot-com bubble. “It’s different this time because of the internet.” I had friends who were graduating college and going to be “day traders” because it was so easy to make money. None of them are in the business today. If you missed the dot-com bubble, you could look at crypto leading into 2022. Matt Damon told you that “fortune favors the brave” in a Super Bowl commercial. It is never different; it is always cyclical.

As investors, it’s essential to stay grounded and not fall for the trap of believing that “this time it’s different.” History has shown that market cycles repeat themselves, and the emotional behavior of investors remains remarkably consistent over time.

In conclusion, Dr. Martin Zweig’s rules provide valuable insights for navigating the investment world. Following trends, managing profits and losses, adapting to change, and avoiding excessive reliance on short-term information flows are just some of the principles that can help investors make better decisions. Ultimately, successful investing requires discipline, objectivity, and the ability to stay true to a well-defined strategy, regardless of prevailing market narratives.

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