Phil Town’s Rule #1, Part #4

[This is part 4 of a multi-part review of Phil Town's book Rule #1, The Simple Strategy for Successful Investing in Only 15 Minutes a Week! If you haven't already, you might want to read Part 1, Part 2 and/or Part 3 first.]

This is a strained analogy, but I think it works.

You are driving along on a quiet Saturday night. Phil Town pulls up alongside you in a big flashy car. He leans out the window and says “Hey, for $25 ($35 in Canada) I can take you to the coolest party ever.”

“Uh, I dunno…”

“It’s at this really gorgeous mansion on the beach. There’s an open bar, a huge gourmet buffet, and dozens of beautiful scantily-clad young people of both sexes who are tipsy and really open-minded, if you know what I mean. Also, the Rolling Stones said they would drop by later and play a few sets.”

Now you are pretty sure this is too good to be true, but there is that slim chance this smooth guy in the expensive car is telling the truth, and it is only $25. So why not? You hand over the money and Phil, assuring you the party is nearby, tells you to follow him. Which you do, weaving in and out of traffic at increasing speeds, making hairpin turns on mountain roads, running red lights, going the wrong way on one-way streets, and so on. Finally, Phil drives off the end of a pier, whereupon you discover that his car is actually amphibious. You stay on shore, watching him sail off into the sunset, calling back to you that the party is just a little farther.

So if by some miracle you have gotten through the main stock selection bits of Rule #1 with your sanity intact and a stock or two to buy, Town has just a little more work for you. We are almost there, you can hear him say.

On page 196 of Rule #1 Town introduces what he calls “the Tools” and what the rest of us investment types call technical indicators. Technical analysis is probably older than you think, possibly as old as the stock market, but at least as old as the familiar charts that show stock prices over time as squiggly lines. It is the developed pseudo-science of chart reading, based on the idea that stock prices follow a pattern that allows you to predict their near-term future. The name “technical” is old too, dating from a pre-computer era when the field seemed high-tech and nearly mystical.

Town is agonizingly ambiguous about the role that the Tools play in Rule #1 and vague about the specifics of how to use them, or even which exact tools to use. He instructs his readers to treat them as something they should follow without hesitation or reflection but also says “I’m not married to the specific set of Tools that I’m about to introduce to you.” He recounts how they have made him money, but seems to sell them to the reader primarily as confidence building accessories that will help a person pull the trigger and invest.

I am not going to conduct a backtest of the Tools. This because: 1) You are probably sick of backtests by now. 2) Town does not quite say that the Tools make money, in fact he is clear that as a stand-alone they do not, so finding that they do not work would not be a refutation of anything. And 3) Town is so unspecific about which tools to use, and how, that whatever results I got could be brushed aside by a true believer on the grounds that I did not do what Town really meant.

The three tools that Town recommends, but is not wedded to, are called MACD, Stochastics, and moving average. They are all, essentially, complex formulas that take only past prices of a stock as inputs and attempt to produce a “signal” that will predict if the stock is on its way up or down in the near future.

I have a lot of disdain for these sorts of tools. (Could you tell?) It is not that the underlying phenomena that they try to capture do not exist. They do. Stock prices really do exhibit some “momentum,” meaning that a stock that has been going up over the past three to six months is a little more likely to go up in the near future than one that has been flat. And over shorter periods, a few weeks for example, stock prices really do tend to revert, that is, stocks that have gone up or down a lot over a short period tend to give or get back some of the price movement right afterwards. These are small effects, but they are real and with enough data a person can prove it.

But these effects are not just small, they are simple. Calculations like MACD are not any more predictive than much less complex measures of price momentum. They have a lot of moving parts, in my opinion, just for the sake of having a lot of moving parts. It makes them seem so much more sophisticated and meaningful that way. In fact, these tools are no more subtle than looking a stock chart and saying “Golly, this has been going up all year. I think I’ll buy some.” or “Gosh, this has really been beaten up this week. I think I’ll buy some.”

Moreover, and here is where Town’s car is revealed to be a boat, these technical buy and sell indicators are by their nature short term. If you follow them you will inevitably be buying and selling every few weeks. Town gives the happy story of a couple who successfully used his system to make lots of money over two years in the stock of the Cheesecake Factory. They bought and sold the stock eleven times during that time. That is almost a trade in or out every month. Understanding, very late in the book, that this is what Town has in mind is probably a jarring surprise for many readers. In most of the book he stresses that he buys companies, not stocks, and that he would never buy a stock he was not willing to hold for ten years. Warren Buffet, an investor known particularly for his patience and long-term view, is cited as an inspiration throughout the book (he appears in the index 29 times) and the title is taken from something the great man said.

And yet, when you get down to it, Rule #1 is a form of investing that relies on a lot of short term trading. Look at any stock’s price chart and it is easy to imagine how profitable it could potentially be to trade in and out, buying on lows and selling on highs, provided, of course, you knew when those lows and highs were. The point is that that is true about any stock, not just that one in a thousand that passed the growth and value screens.

[Links to parts of this review: Part 1, Part 2, Part 3, Part 4, and Part 5]

Books, Gurus, Investing | Frank Curmudgeon | February 10, 2009 8:12 am

13 Comments

By Van Nu, February 9, 2010 @ 3:34 pm

Hello Phil,
I am glad that I have achance to listen your presentation. I really love it. We were more than 90 students from peoria high school. I want to take the class that you have about investing on 15-19 March, that is the only my spring break. Would you offer me the fee $99 again for me please.
I belief that I will success in that project.

Please let me know,
Van
By King, April 2, 2010 @ 2:57 pm

I read Phil’s book Rule #1. Probably one of the most straightforward and useful book ive read on investing in a long long time.

Frankly speaking the fact that this website is bashing phil is more to the discredit of the website rather than phil.

As Warren Buffett says it. Some people get it immediately, others will never get it at all.
By Brandon, June 29, 2010 @ 1:59 pm

Well, doesn’t sound like the poster actually read the book.
By Jim, July 30, 2010 @ 9:08 pm

I read Rule #1 and I have to agree that I was skeptical about using the tools to move in and out of a position. However, this is nit picking at its worst. There is so much great info in that book that I have been able to incorporate into my own trading/investing. I would highly recommend it to anyone.
By ace, November 12, 2010 @ 12:56 pm

Rule #1 was a great read. It’s available on places like Half.com for cheap for anyone else who would like to benefit from it.
By Rikk, December 30, 2010 @ 2:54 pm

Alright Ive gotten through 4 of your posts. I have to admit you have put a lot of work into your review. I still feel tainted by your accusations that anyone who reads this book is a fool. You had to justify being a fool by writing this review. But it is a good review.

Ive been investing since 2007. I thought not the best of timing. But talk about great Deals, huge motes, Incredible safety margins on (Sticker Price) I mean “unrealistic price”.

The book is a catalyst with great information that has put me in the right mindset to invest in strong companies and buy when they get short term damage. The tools do seem to work when your below the “Sticker Price” with the MOS. If your above the MOS price then its a shot in the dark. Your playing with a company that is overpriced. Im not as smart as you because Im a fool for reading the book, but the intent of the tools I thought was an indicator that large investors were jumping into or out of a stock as well which they do in chunks and you can be on the leading edge of that.

Your theme of nobody can win at this game leads me to believe that you struggle with investing.
By Phil, January 9, 2011 @ 1:44 am

The idea behind Phil’s methods is to use the same tools the institutions use to jump on stocks as the institutions jump on stocks. Stocks move up and down because of institutional investing. Of course the technical indicators use past data…what else would they use? The question is, who uses these technical indicators to invest? The institutions! His methods work if you’re disciplined.
By Brandon, March 6, 2011 @ 4:04 pm

Hmm. the name of the domain says it all “bad money advice” — why would you even buy this website domain. What about “goodmoneyadvice” — negative slant causes anyone to be skeptical. I have been making TONS of money using his principles.
By Professor Lembach, March 11, 2011 @ 2:54 am

Who are the biggest liars on the internet: the tough guys, the misery mavens, or the ones claiming they’re MAKING tons of money with some system?

Maybe Rikk is right and there are a bunch of people out there who want to help strangers make TONS of money. But it’s much more likely that there’s just as many malarkey merchants on the internet as in real life. In short, y’uns is talkin’ out yer arses.
By Invester, March 26, 2011 @ 11:55 pm

I use P. Town’s book to make some nice money. Really easy to understand. Every time I stray from the homework and short cut the “tools” I get egg in my face. I think you just need something to rant about. P.S. I rented the book from the libary, use the free internet and pay just $5.00 for a trade that made me $9K in three years. Boy, Phil made alot of money off me. $0. But I also made $3k for another and $6k for yet another.
As a professional who charges people to fix their mistakes, I am always telling people how to fix it themselves for free. Yet, they will not do it. They would rather pay me the big bucks. Some people do have a thing for helping their fellow man. And some people are cynical and that is you my friend.
By slacker, April 30, 2011 @ 12:29 pm

Good read , I’m going to spend more time learning about this topic
By facebook login, September 24, 2011 @ 8:19 pm

Nice post about Phil Town’s Rule #1, Part #4 | Bad Money Advice. I am very impressed with the time and effort you have put into writing this story. I will give you a link on my social media blog. All the best!
By Eric, October 21, 2011 @ 5:58 pm

I started with Rule #1 in 2007. Had to read the book three times to fully comprehend it. It’s well written and easy to read. The concept is what is life changing. I would think a lot of money managers wouldn’t like it at all. It doesn’t not conflict with Buffet’s buy and hold philosophy. I buy and hold a great company I believe in, as long as it’s on sale. If it goes down, I sell and hope to buy more at a lower price. Using Phil’s tools and advice, I’ve doubled my IRA’s. I think that’s pretty good advice.