Strip away analysts' confusing jargon

Serious Money: Financial and economic analysis becomes more sophisticated by the day. For some pundits, that means ever-larger spreadsheets and more use of mathematics.

Increasing complexity does not necessarily mean greater clarity of course: the use of jargon and differential calculus can often be used as a tool designed to confuse rather than to inform. If we are impressed with the obvious sophistication of the analyst, we might be tempted to believe that he also possesses insight. More dangerously, we could start to think that he can make us some money. As an antidote to all of this, Serious Money presents a few rules of thumb to help mere mortals figure out what is going on.

Rule 1: The Taxi Test. Ask any cab driver "how's business?" - and try not to sound like a tax inspector - and you will get a terrific snapshot about the state of the local economy. Lots of moans, undoubtedly, but if he uses the words "picking up" or "slowing down" you have an infallible indication about an imminent economic turning point. Similarly, booms and busts are often flagged by the ability, or otherwise, to hail a taxi. Cab drivers are the best economic forecasters in the world.

Rule 2: The New New Thing Test. Watch what people are buying in your local supermarket and think about your own spending patterns. Competition is the greatest destroyer of profits ever invented. Changes in the competitive environment are much more important than the economic cycle: the latter goes up and down and is ultimately irrelevant. Competition is much harder - sometimes impossible - to deal with. Just ask any telephone company how they feel about competition right now. Most phone businesses are fabulously profitable, yet their shares have recently been as attractive as plutonium. Another example: we know that drinking at home is replacing going to the pub. When you buy your trendy Brazilian and Polish beer from the local supermarket, ask yourself what this might mean for the sellers of more traditional beer brands. Could drinks companies like Inbev, Heineken and Diageo be the victims of a renewed competitive onslaught?

Rule 3: You Get What You Pay For. Market commentators never fail to mock investors for paying hedge funds 2 per cent of funds under management and 20 per cent of any investment performance. That's why commentators comment and smart people make money. It's funny how some hedge fund managers seem to be able to make fortunes for their customers. The best indicator of how good is your fund manager is the level of fees he is able to command in the marketplace. And vice versa. Smart investors know that the combination of mediocre fund management even with low fees is the kiss of death for performance. They also know that eye-watering fees are utterly irrelevant if you are invested with a superb fund manager.

Rule 4: Past Performance is a Guide to Something. All the disclaimers say that historic performance data may not be a good guide to future performance, but it is one of only two indicators we have got (see rule 3 for the other one).

Rule 5: Truth in Clichés. Most market clichés are either approximately or absolutely true. Falling knives are best avoided, trends are very friendly and dead cats do bounce. Selling in May would have done us proud this year. Take "fear and greed", for example: market sentiment is only ever dominated by one or the other. Recent turbulence can be explained entirely by an outbreak of fear amongst many investors. Overly volatile markets can be explained by the incidence of irrational fears and unwarranted greed - we get much more of these than we do reason or sense. We can't measure either fear or greed, which is why academics have invented "behavioural finance". Good luck to them.

Rule 6: The Ultimate Test. There are many unwritten rules in the finance game but rule one, chapter one, is: never admit you don't know. If, by contrast, you manage to find a financial adviser or fund manager who occasionally is prepared to admit ignorance, you have found a wise and confident soul. And with that wisdom will probably come superior performance. Anyone who is heard to say: "I can't answer that question, but I know how to find out" has the necessary self-confidence and savvy to be a top-class money manager or adviser. Test your financial adviser with a question that you know he couldn't possible answer. If he tries, you know you are dealing with a spoofer.

Rule 7. It's Always Different This Time. Every financial market story teller, including this one, searches for past precedent to explain the present and to forecast the future. We look for patterns that repeat themselves. The sad truth is that such patterns are usually castles in the air. The title of Nassim Nicholas Taleb's book, Fooled by Randomness, captures this idea nicely. The proper analyst always searches for a proper explanation, but see rule 6.

Rule 8. Equity Prices Are The Simple Result of an Opinion Poll. That opinion poll is the one about the future. Whether you are thinking about an individual company or a whole stock market, try to figure out what type of future is built into that share price. If, once you have worked that out, you feel more optimistic, then buy. Pessimists see the next rule.

Rule 9. Depressives Not Wanted Here. Pessimists should never get involved in stock markets: short selling is such a depressing - negative - activity. Go and be miserable somewhere else.

Rule 10. Be very careful. People who are very nice do not generally choose the financial world for a career. But there are the odd exceptions.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.