The decision regarding what and when to buy receives the vast majority of investor attention, but may be the least important part of the entire process. It’s not that security selection is unimportant, just less vital than things like the exit and position sizing strategies.

I believe it is a mistake to consider the entry as a standalone, or singular process. Rather, it is merely the front half of an investment process. With this in mind, my entry strategy relies on a few basic concepts:

• probabilistic
• rules based, systematic, price driven
• integrated and consistent with the exit strategy

Probabilistic simply means that the buying (and selling) decisions are driven by factors that put the odds of success on our side. An attempt to achieve perfection is not made, since it cannot exist. It is important to understand that every approach has an error rate. My approach acknowledges and makes allowances for the reality that a notable percentage of investments will not work out the way we would like.

In order to calculate the probability of success, there has to be quantifiable rules that govern the decisions. With consistent rules we have confidence that our future decisions will be made the same way they were in the past. A systematic approach is repeatable. It can be tested and measured. However, for the rules to be reliable, they have to be based on factors that are reliable. Fundamental factors like earnings, book value, cash flow, etc. can be restated or manipulated by any number of things, including changes in accounting rules, one-time events, even fraud. Price, however, is always knowable. Price is freely accessible during every moment of the trading day. It is a known quantity. My approach uses a simple, price driven calculation to determine whether or not a security meets the criteria for purchase.

As said earlier, the entry is just the first part of a complete process. For the process to work, it must provide an avenue for growth along with protection from ruinous loss. An entry decision should be made with a predetermined exit strategy. The exit decision should be made with a predetermined re-entry strategy. The decisions are closely related, the process for making them needs to be integrated – part of a larger whole.

In summary, for a buying decision to make sense it should only be made in the presence of favorable odds and a predetermined protective exit plan. An investor that accepts imperfection as a fact can plan for it and minimize the impact of setbacks. An investor that pins entry decisions on unwavering faith in his own judgment is likely to learn an expensive lesson on the cost of ego.

Next up, Step 3: The Exit.