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Published On: Wed, Nov 14th, 2012

First! What to Avoid

There are many ways to lose money.  The fastest way is to just jump in with no formal training, acting on tips, media  stories, hunches or a stock  broker’s recommendations.  Believe it or not experiments have proven all of these options are no better than throwing darts at a list of stocks pinned on the wall.

Beware promises of incredible riches in next to no time, and avoid “black box” systems.  These promise you that the computer will do it all  for  you.  You need to know they are flat out illegal because they don’t work.

Beware also the “upsell” technique.  This is where you attend a seminar where you are sold another much more expensive seminar in a more exotic location and at that one you are sold another even more expensive seminar at an even more exotic location and perhaps even another one after that.  These usually cost many thousands of dollars and increase sharply each time with the total sometimes exceeding $20,000.  There’s  absolutely no need for that kind of outlay.  Sometimes the up sell technique is more subtle, with each additional seminar costing about the same,  but there’s always another one and another one and another one,  each one promoted as the “silver bullet” where you’ll learn the ultimate secrets.  Again there’s no need  for this.

Avoid advice and opinions from mates and anyone not involved at the professional level.  Don’t listen to  them.  Ever.

Second  -­‐  What to Expect

You should expect to pay for a sound trading and investing  education.  This is a profession like any other so  why would anyone expect to be able to enter the fray with no training whatsoever and be successful?  Would  you go to a Doctor who learnt only from magazines, the information age public toilet wall (the internet) and hearsay from mates?

When starting, it’s important to keep things simple.  You don’t send primary school children straight to senior high school to study advanced calculus.  Start with the basics.  Gain a footing, a solid foundation before you try to get fancy.  Learn how to read charts and trade basic shares before you jump into more complex (and  therefore more risky) derivatives.  Many traders never venture beyond the basics and make very substantial  incomes.

Expect to pay good money for your education.  It’s your very best investment and will repay you many times over.  However there’s no need to spend huge amounts such as those mentioned above.  As a sort of  guideline,  any  training package under $5,000 in total is probably a bit suspect and will more than likely require attendance at more expensive upsell seminars or else it will just be inadequate, leaving you either disappointed or needing to look elsewhere for more.  Anything over $10,000 is just not necessary, especially if  you are new to trading.

You should expect ongoing support, usually via email and regular training seminars or perhaps videos which are rapidly becoming the norm with the advent of widescreen high definition computers and broadband internet speeds.  Videos are much more effective than live seminar or workshops and can be replayed over and over at your leisure.

Remember you need education and training which will cost money if it’s of any value.  Don’t penny pinch but don’t pay too much either.  If you have a  go without a proper education you will lose money.  That’s the only guarantee you should expect.  There’s no guarantee you’ll  be successful because nobody can guarantee you’ll be a good student.  So please don’t ask for any guarantees.  That’s like asking a driving instructor to guarantee  you’ll  never have an accident.

 

 

Fundamental  Analysis

This is best understood as Value Analysis.  In simple terms this means we figure out the net value of a company and divide that figure by the number of shares on issue.  This gives us the correct value per share according to our valuation of the company.  Next we compare our value (price) per share with the current trading price per share on the stock market.  If our price is below the trading price, then we conclude that the market is overpriced and therefore not good value.  If our price is above the trading price, then we conclude that the market is underpriced and therefore good value.  Obviously we only buy stocks that represent good value.  While this is the traditional approach used by most brokers and analysts and certainly has value, it has some serious weaknesses such as:

1. It assumes we have all the relevant and correct information on the company. That’s never the case.

2. It assumes nothing changes after we’ve done our analysis. That’s rarely the case.

3. It assumes our interpretation of the data and analysis is 100% correct every time. That’s never the case.

4. It ignores crowd psychology and that’s the killer mistake that causes this form of analysis to repeatedly fail at market tops and bottoms.

5. It’s time consuming and requires special skills normally possessed only by professionals.

6. Timing is relatively vague and does not tell us precisely when to buy and sell which means we could be buying in a downtrend or selling in an uptrend.

Technical Analysis

Technical Analysis is the study of charts (graphs) of the price action of a stock or an index. It takes no account of the relative value of a share’s price. It simply charts all trading activity by producing a graph which is actually a record of every trade that takes place over a chosen period of time. This requires the use of a computer and quality charting software, and access to trading records from the stock exchange.

This form of analysis is based on the now established and proven fact that share prices do not move randomly, but in accordance with known mathematical and psychological principles and laws and move in predictable ways, and produce recognisable patterns, the properties of which have a remarkable degree of reliability. Technical Analysis has evolved and grown into a multi-­‐billion dollar global industry and no longer carries the “voodoo” badge of yesteryear. It is used daily with great success by millions of professional and amateur analysts.

It is important to remember that the trading data from the stock exchange is a record of the trading and investing decisions of all the market’s participants including those using Fundamental Analysis. It therefore eliminates the killer weakness of Fundamental Analysis listed in point 4 above. It has several other advantages over Fundamental Analysis and these probably explain why global trends indicate it’s rapidly growing use. Some advantages are:

1. Speed and accuracy. A chart going back many years can be displayed on a computer screen and complex mathematical tools can be applied and the results seen all in an instant.

2. Availability. Anyone with a computer and an internet connection can participate.

3. Simplicity. Although Technical Analysis can become complex if you let it, there are enormously powerful tools and methods so simple any high school student can easily master them.

4. Leaves nothing out. Takes full account of the mass psychology which ultimately drives market prices and trends.

5. Precision. Used properly, Technical Analysis tells us what to buy and sell and precisely when to do so.

Long Term Investing

Also known as “set and forget” this normally involves buying a spread of stocks and holding them for an extended period of time. Therefore the investor is not concerned about precise entry and exit points, but simply rides the ups and downs of the market over time. While this may sound appealing, it comes with some serious limitations and risks.

A spread of stocks is required because, over time, some will do better than others and the idea of a spread is intended to reduce the risk because the investor does not know which will perform well and which will not. However a closer examination of this approach is enlightening and disturbing.

Fundamental Analysis is the traditional method of determining which stocks to buy because this investor is notinterested in precise timing. When the list of weaknesses of Fundamental Analysis is taken into account, it becomes easy to see why a spread of investments is attractive. This is because we don’t know which of the chosen stocks will perform. There are three key words in that previous sentence that give the game away: “we don’t know”.

Just what is RISK?

We need to define risk before we can reduce or eliminate it. Broadly speaking it is the potential loss of money and/or time. Most people understand the concept of a loss of money, but few understand the value of time and “time risk” when investing. All forms of diversification of investments are, in reality, a declaration that “we don’t know” and that’s a serious risk in itself.

Some of the biggest names in the investment business such as George Soros have been pointing this out for years, and yet most people still have no idea and blindly follow the spread and set and forget approach. The fact is professionals work hard to make sure they do know which stocks to buy and they get rid of stocks that don’t perform because they drag down their overall results to unacceptable levels.

The other major risk with long term investing is the market crash. Time and again long term investors including professionals get caught and suffer huge losses in crashes. Worse still, history shows clearly that most people enter the market near the tops when the risk is highest. This might seem crazy, but due to a strange quirk of human nature referred to as ‘herding’, most people are attracted to any asset class when it’s booming and therefore most expensive and risky and won’t come near it at the bottom following a fall when it’s cheapest and safest. Long term investors are the most vulnerable because they typically get in near the top.

It gets worse when the time factor is properly understood. For example, from late 2007 to early 2009 most share markets around the world fell heavily and since 2006 house prices in many countries have also fallen heavily. These falls have resulted in serious losses for a huge number of investors. Many of them will tell you it’s only a paper loss unless you sell. Believing that might make you feel better after suffering a loss but it’s a load of rubbish.

 

 

First, it’s a gamble because some investments never recover but let’s assume prices do fully regain their  former levels. That always takes a lot longer than hoped – usually years. You only have to look at charts of  the various stock markets around the world after any crash to see proof of this. Real estate by its very nature  takes even longer. Building wealth is actually a race against the clock to get it done before you’re too old to  enjoy it and time taken to recover from serious falls is LOST time.

So saying it’s only a paper loss is not only a gamble, it displays ignorance of the time loss, a factor which is critical when building wealth. If you double one cent each day for 31 days it grows to more than $10.7 million dollars but if you stop at 30 days it’s not even $5.5 million dollars. That’s compounding, the most powerful force in the universe according to Albert Einstein. Time really is money and time losses destroy its power just as surely as financial losses and that’s something nobody can afford.

Further to this, it is important to remember that all investments are measured in percentage terms. A stock’s performance is described as a percentage such as “it rose 20%”. While this may at first seem simple and obvious, most people do not have any idea of the implications. Here’s the truth of the matter; a 50% fall requires a 100% rise to fully recover and an 80% fall requires a 400% rise to recover. The recovery is always a much bigger task than the fall and that task increases exponentially with each 1% fall. Are you beginning to see the problem?

Most people think the distance back to full recovery is the same as the distance covered by the fall because it  looks that way, but as you can see from the percentages quoted above, the distance back is much greater.  Sometimes you will hear “I have to stick with it now because it’s fallen so far I can’t sell”. That tells you a  huge and very expensive mistake has been made.

This is a first class ticket to poverty because:

1. You cannot be sure it will ever recover (many stocks never do)

2. You don’t know how long the recovery will take (it’s usually years)

3. The percentages are working against you

4. There is usually a terrible loss of time

 

The most successful investors and traders understand that timing is very important if you wish to minimise risk.  There’s just no getting away from this fact.  Fortunately there is a simple solution in the form of Technical Analysis.

Day  Trading

Day trading is defined by Wikipedia as: “the practice of buying and selling financial instruments within the same trading day such that all positions are usually closed before the market closes for the day”.  Needless to say, this requires the trader to be at the computer during the day, using Technical Analysis and watching the price action live as it unfolds.  Most people, apart from full time professionals employed specifically for this cannot do it.  In addition, we don’t get big enough moves over such short time frames unless we trade derivatives.

Derivatives add complexity and are highly leveraged instruments, sometimes well above ten to one.  While this will amplify our gains when we’re right, it can equally amplify our losses when we’re wrong which is quite often.  At its extreme, day trading derivatives can ‘break the bank” as some traders at banks have managed to do over the years.  Day trading is clearly a high pressure, high leverage, stressful environment  and is not suited to most people and is something beginners should avoid like the plague.

End  of Day Trading

End of  Day (EOD) trading is basically  everything  in  between  day  trading  and  long  term  “set  and  forget”   investing.  Trades  typically  go  for  several  days  at  a  minimum,  all  the  way  through  to  many  months  or  even   more  than  a  year  on  some  occasions.  History  shows  this  is  far  and  away  the  most  profitable  approach  to  the   share  market  and  is  open  to  anyone  who  cares  to  learn  how  to  do  it.  The  most  popular  form  is  Trend  Trading   because  this  method  looks  to  identify  trends  near  their  beginning  and  so  trades  are  entered  at  this  point  and   continue  until  the  trend  reverses.  It  is  a  well-­‐known  rule  that  we  must  always  trade  with  the  trend  and  that   “the  trend  is  your  friend”.

Questor have today recommended Vodafone as a buy after their slip to a 13 month low by the close of play yesterday. The stock fell on the back of the deepening concern over the stability of the Eurozone and more specifically Spain and Italy, with poor dividend’s in the US from the Verizon Wireless venture also taking their toll. The telecommunications giant owns 45 percent of the venture and now anticipates a £2.4 billion dividend, which is drastically less than last years £2.9 billion. There was also further concern over the fall in service revenues, which dipped by almost 1.5% earlier in the year. That particular piece of data does not include the revenue from Verizon Wireless however, which if taken into consideration would mean revenues would have actually risen by 1.5%. The stock is currently sitting at 163p, which Questor feels is the result of a knee-jerk reaction from the markets. With many analysts predicting a dividend of more than 14 pence next year there is still plenty of reasons to get on board. The belief is that a 10 pence dividend would be the worst case scenario but that is still an attractive 6.2% payout.

Bovis Homes have continued to rise on the back of development of cheap land it obtained in the aftermath of the crash in 2008. With house sale prices increasing by an average of more than £10,000 year-on-year and the long term nature of their product, the long term gains from this attractive proposition are too good to pass up. A rise of 1.25% today alone, in addition to the steady increase of margins within the house building sector already point towards this being a worthwhile investment.

Meanwhile Aviva, the UK’s biggest insurance company, have continued to underperform. Large investors are currently demanding change, while some shareholders have began to look for an exit. With prices dropping so drastically it will shock many to find that a 7.9% dividend is still on the cards and even with a cut to the dividend next year, many analysts are predicting around 7.7% in 2013. With Pat Regan expecting to assume the role of chief executive in the not too distant future after the removal of Andrew Moss earlier this year, the investors may get their wish — which is expected to aid the insurer in getting back to business as usual.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.

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