Important Disclaimer: Ken Kam, Marketocracy Data Research's Editor in Chief, also is portfolio manager for mutual and hedge funds advised by a Marketocracy affiliate. Before relying on his opinions, always assume that he, Marketocracy, its affiliates and clients have material financial interests in these stocks and hold or trade them contrary to those opinions. Continue reading for more detailed and important disclosures, disclaimers, limitations and material conflicts of interest.

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July 17, 2006

Become a Better Investor: 3 Essential Steps

by Ken Kam

Everyone tells me they would love to be a better investor - but how do you start? Most people have had bad experiences listening to bad advice. They don't know whom they can trust and many have given up altogether.

The good news is that the strategies, tips, and advice I'm going to share with you, along with Marketocracy's online tools can help anyone become a better investor. Based on the investment approach I developed to help me become the No. 1 ranked mutual fund manager in the country, our program is practical, doable, and dramatically different from anything else you've seen.

Many of the tools I developed over the last 10 years are available for free, to use on Marketocracy's website More than 70,000 people have already used our website to improve their skills to become better investors and many have proven to be some of the best investors in the world.

Just how good? We compared the 3-year returns of our members with the top mutual funds in the country. When we ranked them all together, 68 of the top 100 funds were our members. Even more significant, 9 of the top 10 were from Marketocracy.

The Quick Take

These are highlights of the core concepts from my investment approach to become a better investor.

Step 1: Practice, Practice, Practice

Investing is a skill. Like most skills you have to practice to become better. That means you need to buy and sell lots of stocks so that you can evaluate your decisions to see what worked and what didn't

WARNING - don't practice with real money! Marketocracy has developed the most realistic virtual stock trading system that allows you to safely trade real stocks, at real prices, at real volumes, but with virtual money. Now, anyone can manage his or her own $1 Million virtual stock portfolio and practice investing.

Step 2: Focus on What You Do Best

If you focus on what you're good at and stop doing the things you're not you will become a better investor. Simple and powerful; but, most people don't know what their investing strengths and weaknesses are so they keep making the same mistakes. Marketocracy's portfolio management tools help you discover what your strengths and weaknesses are so you can focus on what works and stop doing the things that don't.

Step 3: Find Good Investment Ideas You Can Trust

The reality is that good investment advice is hard to find. That's because investing is a rare skill and to evaluate skill you need to see someone perform over time. You need to see their track record. Have you ever wondered why almost none of the people offering you investment advice show you their real track records?

Practice, Practice, Practice

Any skill, whether it is playing the piano, driving a car, or riding a bicycle, requires some practice to get started and even more practice to maintain one's skills. Even though pure physical ability plays a large part, no athlete would be able to compete at world-class levels without lots of practice.

Investing is a skill too and it takes practice to get better. It is a world-class competition against some of the best investors in the world. Before jumping in with your life savings to compete in the stock market you should practice making lots of investment decisions. Only then can you make an honest evaluation of your skills and where you are weak, try to improve them.

Safety First: Start Investing with Virtual Money

Most people decide to start investing in the stock market and just jump in with real money. That's an expensive way to learn how to invest. Nobody would ever think about flying a plane before they've practiced on a flight simulator first. Don't gamble with your life savings.

Marketocracy has developed a way so anyone can practice investing. We've developed the most realistic virtual stock trading system in the world - an investing "flight simulator," which allows you to safely trade real stocks, at real prices and at real volumes, but with virtual money. Now, anyone can manage his or her own $1 Million virtual stock portfolio and practice making lots of real investment decisions.

When you become a member of Marketocracy, you get an online trading account with $1 Million of virtual money for each of up to 15 portfolios. You place buy and sell orders and Marketocracy executes them by matching your virtual trades with actual trade prices and volumes via real-time data feeds from the NYSE, AMEX, NASDAQ, and OTC exchanges. We apply realistic virtual commission charges and SEC fees for sales proceeds so you experience the cost of trading. Cash earns the money market rate and portfolios are adjusted for stock splits and dividends.

The reason we've developed such a realistic stock market simulation is to find the best portfolio managers in the world. We track and rank the investing performance of our members and manage real money based on our ability to select the top model portfolios. Therefore, we want the simulation to be as accurate and fair as possible.

Don't risk your real money while you're learning how to become a better investor.

How Good Are You?

On Marketocracy's website, we provide you with a Net Asset Value (NAV) Chart of your Investment Portfolio. This shows you a lot more than a brokerage statement. The NAV Chart shows you how well your overall investment portfolio has performed in the same way that mutual funds are measured. Now you can calculate accurate return numbers and compare your performance against any index and any mutual fund using an apple-to-apple comparison and find out how good you are.

Focus on What You Do Best

Waiting for the "fat pitch," is how Warren Buffett compared investing to Ted Williams approach for hitting a baseball. Ted Williams is arguably the greatest baseball hitter of all time. In his book, The Science of Hitting, Ted Williams describes how he mapped the strike zone into 77 cells the size of a baseball. He knew his batting average in each cell. He would avoid balls in his worst cells, even though it was a strike and aggressively go after the pitches in his best cells. That's how Ted Williams became such a great hitter.

Ted Williams' "cells" are similar to different types of investments: strategies, situations, profiles or scenarios that you can invest in. For example: small-cap technology growth stocks, companies that generate transaction fees on mortgages, or software companies with low P/E ratios. These are the investing zones that you should evaluate your performance on. When you see an investment that is in your best investing zones, you should have the confidence to not only step up to the plate, but to go after it aggressively.

The more experience you have in successful investing in a particular investing zone the more confident you should be when you see your "fat pitch." Marketocracy gives you the opportunity to practice investing and to find your investing zones without risking your own money. Waiting for "your pitch" is what we mean when we say, "focus on your investing strengths." If you only invest in opportunities that you're best at you'll be more successful than if you invest in everything.

Discovering Your Strengths

Don't be surprised if you under-perform the market. Most professional money managers under-perform too. What the industry doesn't tell you is that everyone is probably good at something. The key is to find out what that something is that you're good at.

A common mistake that I often see investors making is they think they have to make money on every investment decision. That's one of the reasons so many investors hold on too long to a losing position, hoping they can sell when it comes back and at least break even.

Marketocracy's website provides you with a "Stratification" report that shows the performance of all the positions in your portfolio ranked from top to bottom. Use this tool to look for patterns to your performance. Try to identify the investment profiles, e.g., styles, sectors, strategies, etc. that tend to fall within the top segment of the "Stratification" report.

If there are investing scenarios or profiles that you don't do well in - approaches that don't work well for you stop doing them! If you just stop doing the things that don't work or that you're not good at, you will become a better investor.

Find Good Investment Ideas You Can Trust

I was the co-founder and CEO of Firsthand Funds. When the Firsthand Technology Value Fund became the No. 1 mutual fund in the country, Firsthand Funds grew to $8 Billion under management.

When you become that successful, you get bombarded with stock ideas from brokers, consultants, investment bankers, public companies, etc. I was confronted with the issue, whom should I trust for investment advice?

Sound familiar? How do you decide whom to listen to for investment advice?

Generally, most investment advice sounds good and most investment advisors brokers, financial planners, advisers, and analysts generally look good, sound intelligent, and have impressive credentials. The mutual fund industry is filled with portfolio managers and analysts that were hired because they interviewed well, knew someone, or had a great resume.

The reality is that good investment advisors are hard to find. That's because investing is a skill and to evaluate skill you need to see someone perform over time.

One day, I was watching a baseball game and it occurred to me that stock-picking is a skill just like pitching. If I wanted to recruit a pitcher I wouldn't start by looking at resumes. I'd put him up on the mound and watch him pitch against the best batters I could find.

That's why I founded Marketocracy. To track, analyze, and evaluate the investing performance of anyone that wants to try. Through our web site you can track anyone offering you investment advice. Set up a model stock portfolio for each of them. Whenever they call you with an idea put it into their model portfolio so you can see how they do. Marketocracy will help you track and evaluate their performance. If they are performing well, then you should pay attention. If they aren't, then stop listening.

When your broker calls with a stock tip, buy it with virtual money. When you receive an investment newsletter with investment ideas, buy them with virtual money. When you hear a financial wizard on CNBC giving you their top 3 stocks they like, buy them with virtual money.

Now you have ideas of what to buy, but generally, you'll have to make judgments about how much to buy and when to sell. For example, when a Wall St. equity research analyst recommends Cisco is a "Buy" how much should you buy? At today's price? If you already own stock in Cisco should you hold or buy more?

Every advisor has good stock picks and bad picks. They tend to tell you only about the good ones. The only way to judge an advisor is to look at the whole picture over time making sure to include all the bad stock-picks as well as the good ones.

Once you know who is giving you good advice, you can improve your returns by getting rid of the people who are wasting your time and costing you money and giving more of your time and attention to the people whose advice is making you money.

Final Thoughts

Everyone wants to become a better investor, but like any skill, it takes practice to get better. Once you discover what investing approach or areas you're best at, focus your efforts there. And before you listen to anyone offering you investment advice, evaluate their performance.

If you take these three essential steps, you'll be well on your way to becoming a better investor.

November 1, 2005

Focal Point: Antidote for Rising Rates

Most of the things the politicians, the media, and big corporations want you to be afraid of, you really don't need to be afraid of. Let other investors on Wall St. run around like chickens and use their fear to create your opportunities to buy stocks in key areas like energy. However, there is one thing I do worry about and so should you: rising interest rates.

Rising interest rates are bad for stock prices and I'm afraid the Federal Reserve is going to raise interest rates too far. In the last 50 years, the Federal Reserve has successfully managed interest rates to produce a soft landing only twice -- a poor track record indeed.

There is an antidote to rising interest rates! It's called growth.

By "growth" I do not mean investing in what Morningstar, and others, commonly refer to as "growth stocks." To be classified a "growth" stock by Morningstar a stock has to exhibit high growth in earnings and a high P/E ratio. A high P/E ratio is all the proof I need that Wall St. has already discovered and priced this stock at a premium. When interest rates rise the stocks with the highest PE's have the farthest to fall so buying these stocks now would make your portfolio more vulnerable to rising interest rates, not less.

The growth stocks I want you to buy are the stocks with high earnings growth, but that Wall St. has not yet discovered. These undiscovered growth stocks have lower P/Es and are likely to be classified as "value" or "blend" stocks and lumped together with lots of other stocks that are selling at low P/Es, and deserve to be.

The fears that have seized Wall St. today have put growth on sale. For example, the energy companies that we recommended in May such as Valero (nyse: VLO) and Edge Petroleum (nasdaq: EPEX) and Chaparral (otc: CHAR) have delivered terrific earnings growth over the past year, but still trade at below average P/Es and are classified by Wall St. as "value" stocks.

I also want you to invest in stocks like Click Commerce (nasdaq: CKCM) with terrific growth prospects that are not tied to the Energy sector and that the market hasn't already discovered.

Click Commerce just reported that for the 3rd quarter revenues grew by 130% and earnings grew by 176%. For all that growth, CKCM trades at a price-earnings ratio of 18, a small premium over the S&P 500, which has a PE of about 16. But I don't need to tell you, that the S&P 500's revenues and earnings have not grown by 130% and 176% since last year. Buying Click Commerce is buying growth at a bargain price.

When earnings grow this quickly, even rising interest rates cannot stop the stock price from going up. Here's why. Suppose that over the next year, CKCM's earnings double (which would actually mean growth slowed to 100% from 176%). For the PE ratio for CKCM to remain the same at 18, its stock price (the "P" in the price-to-earnings ratio) would have to double, since the earnings or "E" doubled. That would be a fantastic outcome.

If interest rates keep rising, the PE of this, and every company, will fall. Rising interest rates increases the discount rate for future cash flow and lowers the net present value. If a company's future earnings grow fast enough, it can out run the rise in interest rates and keep the company's stock price rising. So, if CKCM earnings double, its PE ratio would have to decline more than 50% before the stock price would go down.

The faster earnings grow, the more protected we are from being hurt by rising interest rates. That's why I'm recommending you buy Click Commerce today.

Click Commerce, Valero, Edge Petroleum and Chaparral are the kinds of stocks that should form the core of your portfolio because they provide downside protection and the best opportunity for upside appreciation. But you should have several more stocks in your portfolio to reduce your risk. Over the next few months, I'll be hunting for more.

October 1, 2005

Focal Point: Navigating Choppy Waters

The toughest stock market to invest in is what I call a "choppy market" when there is no clear market direction. That's the kind of market we've been in since the beginning of 2004 with the market changing direction several times. Making money was a major challenge.

Fortunately, I have access to an extensive database of the best investors in the world to tap into. I found there were lots of investors at Marketocracy that did well in a choppy market and in fact, they were knocking it out of the park. After pouring through reams of data we developed an approach that is more responsive to market changes and can navigate through choppy waters. At the end of April of this year, we made adjustments to our investment process and the results have been dramatic. Since April we returned 21% vs. 7% for the S&P 500.

Here are the key lessons I learned that can help you invest in a choppy market.

Respond quickly to market changes: Since no investment strategy works all the time, to consistently beat the market, an investor needs to adjust strategies as the market changes. That's a given and in up markets and down markets we have enough time to identify trends and make adjustments. Over the last two years we have all found that choppy markets don't give us long enough trends and we have to respond quicker to changes but not too quick, otherwise you'll be zigging while the market is zagging.

I have found that very few investors can respond quickly and successfully to market changes. One of the best measures of your ability to respond to market changes is our Batting Average calculation. It measures how consistently you beat the market. We have found that beating the market around 70% of the time within 30 days is a good target.

Become a generalist investor: Responding quickly to market changes makes sense if you have the flexibility to change to an area of the market where you are a skilled at picking stocks. The more areas you are skilled in the higher likelihood that at least one of your areas will be a good place to invest.

Generalists are skilled at investing in several areas of the market. They are rare. Most investors are specialists - expert at investing in a specific industry/sector or implementing a particular investing technique. When the market changes, specialists can't change and shouldn't change. If you're good at picking networking technology stocks it doesn't mean you're going to be good at picking oil stocks just because oil stocks are running.
We developed a way of measuring performance zones areas of the market where a portfolio manager has demonstrated investment skill. We look for managers that have multiple performance zones and therefore, the ability to change zones as the market changes.

You need a team: No single person has enough expertise to invest well across all industries. This is why you need a team. And the expertise of the team members needs to match the opportunities available in the market. The more pockets of opportunity we can go after the better.

By picking a diversified team you can reduce your risk and volatility. We assemble our team of generalists based on diversification by sector, by style, and several other criteria - to reduce their correlation and increase our responsiveness.

The key to my investment process at Marketocracy is finding the best investors for the current market. In a choppy market I discovered it is best to have a team of generalists flexible investors that can find pockets of opportunity in several areas of the market and can change as the market changes. At Marketocracy, we've discovered that generalists are rare but we have lots of them and we've assembled a team that can help you steer your portfolio through the choppy waters of today's market.

September 1, 2005

Focal Point: Marketocracy's Team Investing Process

Marketocracy's Team Investing Process is a concept that I started over ten years ago and today, continues to evolve and improve. To explain our process it helps to go back to the beginning.

Firsthand Experience Makes a Difference: Before founding Marketocracy, I founded Firsthand Funds over ten years ago based on the belief that someone with firsthand experience and a network of contacts knew more about their industry than the legions of people hired by Wall Street, most of whom have never worked in industry.

I gained my firsthand experience as one of the founders of a successful medical products company. We developed a catheter that we took through FDA approval (non-trivial) and we manufactured, marketed, and sold it. We built a successful business that we sold and kept the remainder of the company, which eventually went public.

Over time, I developed an extensive network within the industry, particularly cardiologists across the country. So, when I invested in medical products and pharmaceutical companies while co-managing the Technology Value Fund I was able to tap into the opinions of the best research team in the world the people on the front line using and purchasing the products of the companies I was investing in.

I learned that even a bad product in the hands of the best cardiologist could work well and look great in a marketing video to promote the company. Until you test it in the hands of the average cardiologist you really don't know how well a product will really work. I learned that nurses see how the products works in the hands of all the doctors and they aren't paid by product companies. So, when nurses give their opinion about a product I listen.

My partner did the same in information technology stocks and our fund was ranked by Lipper as the #1 fund of all mutual funds for the 5-year period ending September, 1999 delivering 56% per year.

Team Investing: No single person has enough expertise to invest well across all industries. This is why you need a team. At Marketocracy I've taken the firsthand concept and expanded it to every sector and every stock because I wanted an investment process that works even when the stocks I know best are out of favor.

As the market changes, the team needs to change because the expertise of the team members needs to match the opportunities available in the market. This year we needed expertise in the oil industry. Technology stocks are not always in favor and when tech stocks aren't performing you don't want a tech stock expert picking oil stocks for you.

Team Research: Even great investors rarely have all the pieces of the investment puzzle. For most stocks, there are only a handful of issues that can drive a stock to double within the next 2 to 3 years. The secret to good stock research is to frame the right questions about the big issues, and then ask the people best qualified to answer them.

At Marketocracy, we have always used the investors with the best long-term track records to help us pick stocks, identify the issues, and frame the right questions. Recently, I asked the broader Marketocracy community if they could help me understand a piece of the investment puzzle on Elan (nyse: ELN) and their multiple-sclerosis drug, Tysabri. I heard back from members that were physicians, MS patients, nurses, lab technicians, industry executives, scientists, etc. Together, they helped give me a 360 degree view and made me comfortable making Elan the second largest position in the m100 portfolio. You can see some of the Elan results in the article on page 4 in this month's Marketscope.

This research process has worked well for me at Firsthand Funds and I am confident will work even better at Marketocracy where the talent base is broad enough to research and find great investments in every corner of the market.

August 1, 2005

Focal Point: Learning from the Best - the m100

How can the Marketocracy website help you become a better investor? One way is to utilize the wealth of information found in our Clubs and Forums.

Only members with the best investing performance are allowed to post to our Forums. Every post shows the relative performance of the person posting. m100 members are indicated by an orange star, the top 100 in any category by a blue star, and current top quartile members by a green star. Here you'll find some of the most well thought-out advice from the best investors in the world.

These Forums are a vibrant medium for members to gather specific insight about a particular stock, industry or sector and investing in general. Each category has hundreds of sub-categories, from specifics about particular stocks to general investing principles to social topics. The members that have proven successful over time are those that are able to adapt and refine their investing techniques. By following discussions and posting questions to the best investors in the world, you will get specific advice on what works, and what doesn't. By following discussions and paying careful attention the advice that the best investors post, you will have the ability to refine and adapt your skills to become a better investor.

Although the Forums are similar to other message boards, the posts on Marketocracy's site are by members who have shown their success over a long period of time.

You can look at the performance of those that post by clicking on the member's screen-name for a detailed report on member's mutual fund/s. The report includes a huge amount of information about the fund's price history, the fund's positions by sector and style, returns versus the S&P 500 Index, fund rankings since the fund's inception, the fund's alpha and beta, turnover and a profile about the fund manager. You can check up on how the person has fared over time, so you know who you're getting advice from.

When you look up a stock, beneath the basic information and chart, the website generates a list of forums where the company has been mentioned. In addition, the website also shows you related stocks and Forums that discuss the particular industry. By going to these forums and looking at what the best investors have written about, you will be able to hone your investment decision-making skills.

Members of the site also have the ability to join clubs with members with similar interests. Clubs provide an excellent learning opportunity for those interested in learning more about a particular type of investing. Those that want to learn about Warren Buffet's principles for investing can join the Warren Buffet Fan's club. Or those that wish to develop an understanding of contrarian investing can join the "Contrarian Corner."

The goal of the Warren Buffet Club is to learn how to invest like Warren Buffet, and many members include m100 membersnot bad tutors. Asking about a particular stock in this forum will likely yield an enormous amount of information about how Buffet would approach the stock with regard to everything from current liabilities to assets to future possibilities for the company.

This environment of competition helps draw the best investors to the site, which is great for those that want to become better investors. Competition is often the best way to develop your skills, so creating a club with some co-workers or family members may inspire you to outdo your boss or even continue your sibling rivalry in a more adult arena.

By collaborating and bouncing your ideas off the best investors you'll prepare yourself to make better decisions. The Clubs and Forums allow you to interact with the best investors in the world, asking questions, joining clubs and using the website to its maximum potential is what will set you apart from other investors.

July 1, 2005

Focal Point: Finding Nuggets and Leveraging the Community

When I started Marketocracy I thought I'd find lots of people like me, with firsthand experience in an industry that also had a passion for investing. And I did; but I also found lots of skilled investors that had different approaches to investing than mine. That has been one of the amazing surprises about our investment process.

Personally, I do fundamental analysis and like to invest in stocks that I think have a good chance of at least doubling within 2 years. Why a double? If a stock doesn't have at least a chance of doubling, it probably isn't worth the time and effort needed to research and follow it.

I try to identify two or three things that if they happen could drive a double in the stock's price. I call those nuggets and I call this approach prospecting for nuggets. A nugget is more valuable the higher the probability it will occur and if it is undiscovered.

Look where you have an advantage over most of the market. If you look in places that have already been picked over by lots of people, you probably won't find many nuggets. You need to look where most people aren't looking or at things that most people aren't looking at. A good place to start is in the industry and with the companies that you have firsthand experience or knowledge about. Often, you'll know more about new products, customer acceptance, and the impact on the market sooner than Wall. St. analysts do.

Develop your nugget hypothesis. A framework I find useful is to identify the key drivers of value for a company. Generally those drivers begin with the components of earnings and earnings growth, e.g., sales, sales growth, and margins. Next identify the events that could change those drivers significantly. For example, if the FDA approves a new drug it will provide a new revenue stream worth X, if an existing product gains access to a large new market revenue will increase by Y, and if a competitor is eliminated it will reduce alternatives and can lead to higher margins.

Next, you need to evaluate and assess your nugget hypothesis: will it have the expected impact and what is the probability that it will occur. I like to develop a list of questions that help me understand the situation better and help me make that assessment. If I have firsthand experience I may be able to answer many of the questions myself. More often it really helps to know the right questions to ask and of whom to ask the questions. For instance, Elan is one of the stocks we wrote about in this issue of Marketscope. One of the critical questions is whether or not Elan's drug, Tysabri is effective in monotherapy. Ideally, I'd like to be able to ask that question of physicians or patients that have used Tysabri to treat MS and can provide comparison to existing treatments. I don't have that personal experience but by finding the right people to pose the question to I can make a good assessment of Tysabri and Elan.

There is a parable of the blind men, each holding a different part of an elephant, each with a different perspective of the same animal based on their experience. One man feels the trunk and declares, "it's a snake!" Another feels the leg and says, "it's a tree." Still another touches a ear and thinks it's a fan. And the one that grabs the tail thinks it's a rope. Few people see enough aspects of a company to put the entire story together themselves.

Marketocracy has developed a community of investors with firsthand experience in almost every area of the economy. Our goal is to tap that vast network of expertise and insight, to prospect for nuggets, and generate good investment advice.

June 1, 2005

Focal Point: Investing In Your Zone

Waiting for the "fat pitch," is how Warren Buffett compared investing to Ted Williams approach for hitting a baseball.

Ted Williams is arguably the greatest baseball hitter of all time. In his book, The Science of Hitting, Ted Williams describes how he mapped the strike zone into 77 cells the size of a baseball. He knew his batting average in each cell. He would avoid balls in his worst cells, even though it was a strike and aggressively go after the pitches in his best cells. That's how Ted Williams became such a great hitter.

Ted Williams' "cells" are similar to different types of investments: strategies, situations, profiles or scenarios that you can invest in. For example: small-cap technology growth stocks or companies that generate transaction fees on mortgages. These are the investing zones that you should evaluate your performance on. The zones you have a track record of successfully investing is where you should focus and look for your "fat pitch."

Marketocracy has a number of tools that can help you identify where your investing zones are; but here's a new one that I think you'll find interesting because it is easier and quicker to calculate. At the end of the day investors want to make money. So, let's calculate where you've made money and compare that to where you're currently invested.

If you're managing a stock portfolio at Marketocracy - you can download a file of all the positions you've ever traded in your portfolio. Under your portfolio's Stratification Report, check: ( ) Show All Positions and then Download the data file.

Sum up and calculate the percentage of your gains by sector or industry and by market cap (see Table 1). This investor has five zones that they've made most of their money in.


Next, sum up and calculate the percentage of your portfolio's value by the same sectors or industries and market cap. This is where your portfolio is currently invested (see Table 2).

If you're currently invested in the same gain zones you made money in, then you're investing in your zone. The investor in the above example is investing in their zones of Consumer Discretionary and Info. Tech.; but they are investing outside their zones in Financials.

When Ted Williams saw his "fat pitch" in one of his best cells he got a lot more aggressive swinging the bat. When you see a investment that is in your investing zone, you should have the confidence to not only step up to the plate, but to go after it aggressively.

The more experience you have in successful investing in a particular investing zone the more confident you should be when you see your "fat pitch." Marketocracy gives you the opportunity to practice investing and to find your investing zones without risking your own money.

May 1, 2005

Focal Point: MoneyBall Indicator - Are You Making Money?

The book Moneyball describes how the Oakland A's use statistics to select and manage baseball players. Their insight is simple and powerful. In baseball you win games by scoring runs. If you want to score more runs, figure out what player attributes correlate to scoring runs and hire the players who best exhibit those qualities.

With investing the objective is to make money. If you want to improve your investment returns, what statistics should you track? Two that I have found useful are what I call the winning percentage and the win/loss ratio.

To calculate the winning percentage you'll first need to make a list of all the stocks that you've ever held in your portfolio. Next, for each stock (or position) on the list, mark the ones in which you've made money over the life of your portfolio. Total the number of positions in which you made money and divide it by the total number of all positions. The resulting percentage is your winning percentage.

The winning percentage tells you if you're doing a good job of choosing which stocks to buy. The higher your winning percentage is the better. A 50% winning percentage means that all the time and effort you put into selecting stocks adds almost no value. You would have done just as well flipping a coin to select stocks. A winning percentage of 66% would be excellent and would rank among our best investors on this measure.

The win/loss ratio takes the winning percentage a step further. To calculate it, you will need to know how much money you've made or lost on each stock over the life of your portfolio. Calculate the average profit per winning stock and divide this figure by the average loss for all the losing stocks. The result is your win/loss ratio.

I use the win/loss ratio to tell me whether I am doing a good job of managing the stocks I've chosen for my portfolio. No one makes money on every stock they buy, so it is inevitable that you will have some losers. The trick is to recognize your mistakes early so you can close your losing positions before they lose too much money. And hang onto your winners long enough to maximize your gains.

An investor with a winning percentage of only 50% can still generate great overall returns if their winners make them more money their they lose on the losers. The very best investors we track have win/loss ratios between 2 and 6. A win/loss ratio of 2 means you're making twice as much on the winners as you lose on the losers.

Just like MoneyBall helps the Oakland A's look at the right statistics to help them win baseball games, the winning percentage and win/loss ratio can help you zero in a couple of key attributes for making money as an investor: are you investing in the right stocks and are you making more on your winners than you're losing on your losers.

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