Dennis Gartman’s first rule of trading: A commentary

Dennis Gartman’s first rule of trading:  “Never, under any circumstance add to a losing position…. ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin!”

Horizens AlphaPro Gartman Fund (source TD Waterhouse)

Dennis Gartman is a colorful media figure who apparently has a trading business on the side.  Fabrice Taylor, in an article in the Globe & Mail, “Dennis Gartman needs less talk, more action“, points out that for all of Gartman’s media presence, he doesn’t do all that well as a fund manager.  The Horizens AlphaPro Gartman Fund ( closed at $9.00 yesterday.  Fabrice Taylor, critical that Gartman’s fund was still at only $9.12, wrote almost a year ago (Nov. 30, 2009):

But the market is up 30 per cent since the fund launched. What’s up with that? Mr. Gartman didn’t get back to me, but the people at Horizons AlphaPro tell me the fund is intended to be market neutral, meaning it won’t move with the market. Why? Because it’s long and short, and supposedly constructed in such a way that the market’s performance has no net effect on the returns. The only thing that does have an effect, in theory, is the manager’s skill. It may be early days, but Mr. Gartman’s performance has been found wanting.

He’s expected to return between 6 and 12 per cent regardless of the market. Eight months in, he’s nowhere near that. …

Nearly a year later, he’s still nowhere near that point.  I thus view Gartman with a great deal of skepticism, particularly because he shorted Berkshire Hathaway, calling Warren Buffet an “idiot” on account of his (Buffet’s) buy and hold strategy.  Gartman explains his first rule:

Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

With all due respect, I doubt that averaging down is what killed those companies.  Usually what destroys investment companies is unwise use of leverage.  In my view, the goal of business is to be in business tomorrow.  So I don’t tend to use leverage for momentum stocks but for income stocks.  That way, short of a dividend cut, I will always be able to pay the interest and I won’t have to go bankrupt.  In addition, it is probably unwise to depend on the margin in your account to cover the leverage.  More credit (such as a HELOC) has to be laying in wait to cover a margin call, if God forbid, the market drops to that point.

Averaging down vs. Gartman

So Gartman says never to average down.  Never buy more of stock when it goes down–the market is telling you that you are right when you buy stocks on the rise.  Yet my experience teaches me that this is wrong.  Consider the following positions that I averaged down on during the last two years since the beginning of the crisis:  Western Gold Fields (, now NGD) up 252.33%; Crescent Point ( up 37.28%, plus 7% dividend; NAL Oil and Gas ( up 16% plus 8.6% dividend; Barrick Gold (ABX) up 45%; Midway Energy (, formerly TFL) up 294%; Great Plain Exploration ( up 30%.  Some of my picks are still weak, but nothing is losing me any substantial capital.  Overall, the current positions in the portfolio are up over 62.3% above my book value.  By Gartman’s rule, I should pick my own style of trading over his, since his fund is still in a net zero position over the same period.

Why does averaging down work for me?  Here are some rules for averaging down:

(1) It is not a good idea to average down on stock that is in trouble. I did not average down on BP.  Nor Nortel.  Nor would I have averaged down on BreX or Enron. I sold my Enbridge ( after the first oil pipeline spill (though that turned out to be wrong); I dropped Centerra Gold ( after the coup in Kyrgyz Republic (also wrong).  And I am thankful that the stocks collapsed before I began trading, but I doubt seriously I would have been caught in that mania.

(2) Begin with an appreciation of the value of a company. Perhaps it is an income stock like or  Perhaps a junior oil company with a good team of proven oil men (like  I like commodities because my hunch is that fiat money will diminish in value while commodities will retain their value.  So I like trading gold mining stocks.  I now begin by easing into a long position or selling a put option to reduce the cost of entry.

(3) Understand that the market is not only sometimes wrong but often wrong.  Gartman’s point that a trader should let the market tell him whether he is right must be refined.  The market may be right over the long haul but in the short run, it is usually over buying or over selling.  The dictum of Buffet is better, “Be fearful when others are greedy and greedy when others are fearful”.  This is clearly saying a contrary message to Gartman’s first rule of trading.  The reason Buffet’s advice works is that, as  he learned from Benjamin Graham the author of The Intelligent Investor, publicly traded companies have two values:  (i) the value that the market places on it; (ii) the value it has based upon an evaluation of its balance sheets and its potential earnings going forward.  This second value, which is the most overlooked during periods of market insanity, represents the worth of the company if it were to be bought in a private sale.

(4) Pay attention to book value. Book value (a.k.a., shareholder’s equity) is an very important consideration.  Graham recommends that a defensive investor never buy stocks that are selling at a price to book of more than 1 1/2 times. He also taught that buying a company at a  price to book ratio of 1.0 means that the buyer is getting the company for nothing, for the buyer pays only for the shareholders’ equity, at a one to one value, but pays nothing whatsoever for the company’s future profits.  During the 2008 market crash, many stocks were selling at below shareholders’ equity.  An averaging down strategy makes it possible to take advantage of such deals.  But paying attention to book value saves the investor from sinkholes like the companies which often had negative book values.

(5) Maintain sufficient cash or credit to be able to average down.  When I first started trading I would shoot my wad and then there would be nothing left with which to average down.

(6) It is permitted to “average back up”; i.e., to take profits from the stocks as they come back up, especially when it helps to reduce leverage.

The economic consequences of the culture of death

How should the Righteous Investor consider the question of abortion?  Well, it is repugnant from the standpoint of the Christian world view.  But should investors have a different take?  Well, here is a possible consideration.  It is possible to quantify the value of life by multiplying the average earning potential times 38 years (18-65).  The typical human being in the USA should be able to earn a modest $25,000 per year.  In this case, their lives would be worth $950,000 each.  Since there have now been 50 million abortions in the United States, the total value lost equals $950,000*50 million, or 47,500,000,000,000; 47.5 trillion dollars.  Now if we consider that the unfunded liabilities of the United States is around 100 trillion, doesn’t the abortion policy seem quite ridiculous from an investor’s point of view?  The earnings of these dead people could have quite easily made a huge dent in this coming economic meltdown in the United States.

CPI is a lie

The government inflates the currency and then determines the rate of inflation, the so-called CPI.  But the CPI is a lie.  It is supposed to be at or near zero in the US and yet prices for most necessities are increasing.  This year, for the second year in a row, Social Security benefits will not rise for American senior citizens.  So reports Market Watch:

Understand that the CPI does not measure everyone’s cost of living. Rather, it is designed to represent changes in the market basket of goods and services bought by the average household each month.

However, seniors’ market basket is different. It consists mainly of such items as food, energy, taxes, transit fares, tolls and, of course, health care, such as insurance, doctors, prescription drugs, hospitals, assisted living and nursing homes.

These costs are not falling — they are rising quite rapidly. As a matter of fact, health-care costs are just about the only item that did not dip for even one month during the recession. has alternative to the CPI to measure using the data that was in force in 1990, which gives a current inflation rate of about 8%.  Thus, Americans depending on Social Security are rapidly falling behind and the reason is that the CPI is a lie.

The Chief Export of the United States: the US dollar

A few days ago I had a discussion with Andrew regarding whether money is a commodity.  I tended to think of it as an intermediary which made trade possible.  It is far more efficient to trade in dollars than it is to determine what the price of oil should be in corn, iron ore, oranges or rubber.  Therefore, as a store of intermediary value, the trade between trades, money is not really a commodity–i.e., it is not the goal of trade but the vehicle or means to achieving the goal.  So I trade my labor for dollars, and then, my dollars for goods, and so forth.

While reading, “It’s the Money, Stupid: Papering over our economic problems” by Jeffrey Bell and Sean Fieler, it dawned on me something that had puzzled me for many years.  I wondered how the United States has been able to maintain 30-year trade deficit with other countries.  Bell and Fiehler argue that a paper money system, rather than being able to better smooth out downturns in the debt-based business cycle, has become debt itself:

… there is no viable way to maintain the Fed’s current role as guarantor of short-term financial stability and still reform the paper money system so as to remove its tendency toward the unsustainable accumulation of debt. For the paper money system that the Fed manages not only encourages debt, the system is debt.

They continue:

The self-perpetuating feature that has kept this perverse system alive is the dollar’s position as the world’s reserve currency. Before the dollar assumed this role between the two world wars, gold—something of independent value and no particular country’s liability—was used to settle international payments between central banks and composed their primary reserve asset. But with the dollar performing those functions, its oversupply has often been absorbed abroad. So Bernanke and his predecessors in the paper-dollar era have been able to print a lot of new dollars, over time inevitably driving down the global value of the dollar, without necessarily generating domestic inflation. That is the enabler of, among other things, relatively painless federal budget deficits. For a red-ink-hemorrhaging Greece or California, the specter of default is always on or near the table. For Bernanke and Congress, colossal deficits are just another day at the office.

Clearly, then, the US is able to maintain the trade deficit because the dollar itself has become sought after international intermediary of trade, not only between US citizens within the borders of the United States, but between citizens of diverse countries trading commodities in dollars on international markets.  The dollar has thus been a useful product.  Furthermore, many countries have vast reserves of US currency and some private citizens living in countries such Russia and Argentina, hold vast sums of US dollars.  So I have finally to suggest that Andrew was right and that we can see money as a sought after commodity in and of itself.  It is a commodity that facilitates trade and makes it possible to quantify, albeit in relative terms, the market prices of diverse currencies and commodities, as well as thousands of products.  The dollar has therefore made the trade deficit possible because the Federal Reserve has had the unique advantage of creating new money as the world’s needs grew.  Countries like China and Japan have trade surpluses with the United States and have built up huge dollar reserves which they can now use to buy supplies or invest.  The dollar itself has been the chief export, and so therefore, there has never been a real “trade deficit”, but rather, a willingness of trading partners to accept the greenback itself in exchange for the goods that they were peddling.  The US has obviously been the winner in this trade since the cost of creating dollars is minimal, especially as compared to the real goods that have been traded from abroad.

Clearly, this is a unique and privileged position that the US dollar enjoys.  It is however not carved in stone that the international community will always trade in dollars.  The Federal Reserve is squandering this status, because it is determined to keep the US afloat by creating trillions of dollars more.  But like any commodity of which there is an oversupply, the value of the dollar will plummet, and then its usefulness as an intermediary of trade will disappear.  At that point the privileged status of the dollar as the chief export of the United States will be lost and there will no longer be a “trade deficit”.  When that happens, goods from other countries will be difficult to obtain, and hyperinflation in the United States will be the inevitable result.

The best of worlds: the anthropological optimism of liberals vs. anthropological pessimism of conservatives

One of the significant differences between today’s conservatives and today’s liberals is that conservatives generally have a dim view of human nature and a deeper faith and trust in God.  So we are anthropological pessimists and theological optimists.  On the other hand, liberals want to make government bigger because they think it possible for human agency to procure well being, while conservatives want government to be small–with the exception of the military, for we believe that power corrupts and therefore government needs to be severely limited in scope and size, but that being said, the military is necessary because the world is an evil place and we need protection from other human entities such as terrorists and hostile foreign powers.  The liberal, on the other hand, optimistically wants to put power into the hands of bureaucrats as the solution to human woes, sees nothing but benevolence coming from larger government, but wants to reduce the military, evidently because there is no serious threat of terrorism or foreign invasions–i.e., anthropological optimism.

Conservatives are increasingly longing for the gold standard and today are buying large quantities of gold.  Liberals tend to support Keynesianism.  The difference again comes down to anthropology.  Liberals believe it is possible for an all benevolent bureaucracy to control the money supply.  I would generally agree that Friedman’s monetarism, as a middle position between Keynesianism and the gold standard, is probably the best system, but only when guided by wise and prudent leaders.  But when manipulative control-freaks are in charge of government, monetarism is too easily manipulated to rob the population through inflation.  Therefore, I’ve concluded that a gold standard, while placing limits on growth, would lead to greater stability and prosperity.  The gold standard places limits on human manipulation.  It would therefore prevent inflation, because gold is scarce and cannot be easily made un-scarce, as can fiat money; and it would lessen the swings in the business cycle, for the ability to demand gold for bank notes would greatly limit the expansion of credit.  Keynesians actually believe that an all benevolent government can prime economies for the well-being of all.  It is the replacing of of faith in God who cares for his creation with faith in humanity.  The gold standard recognizes human corruption and therefore seeks to curtail the evil tendencies in mankind–this may also slow growth, but that is the price that has to be paid to prevent the money system from falling into the hands of inept (viz. Bernanke) or corrupt (viz. the Democrat party) leadership.

It all comes down to a basic principle of St. Paul in Romans 3.23:  “For there is no distinction, since all have sinned and fall short of the glory of God.”