Of course in the end it all ended in tears for many amateur investors. Although I did well at the time the mistake I made was calling a bottom on the carnage and bought back too early. I made the fatal error of looking at relative prices. For example if something was £35 in 2000, well surely it must be worth £5. No way, it was worth 5p before I knew it. A lot of people lost an awful lot of their hard earned savings at this time and it was probably their first foray into the stock market. Many of them would never return again to the world of investing. Looking at a valuation of a company in relation to its expected profits is so important and also accepting that sometimes you make a mistake a cutting your losses are major lessons I learnt in the early part of the new millennium.
Then in my early investing years I took all those magazine and newspaper tips with a little too much enthusiasm. Share magazines and Newsletters can be helpful to give you the low down on what’s going on in the market but the weekly buy or sell tips are often fairly speculative and you can easily lose your shirt if you’re not careful. Many small cap shares in the U.K. are sold via market maker intermediaries. These guys set the price of shares and of course they read these tips and move the price up as soon as the tip is published. Readers buy immediately at this inflated price. I often find some good ideas in magazines and through internet sites but I often hold back, take a good look and then wait a week or so for the price to settle down a bit.
Internet bulletin boards can also be a curse on the small investor. During the tech boom in 2000 dubious posters so called “pumped and dumped” dodgy stocks on the basis of “hot inside information”. 95% of the time most of the information was wrong or even intentionally misleading with the intention to try and get uninformed investors to buy shares in the worst type of companies. The British site www.iii.co.uk has good discussion forums but everything that is said should be treated with extreme caution. Always do a check on information before you go ahead and trade. I well remember trawling these bulletin boards looking for my next investment and ending up with egg on my face most of the time.
Then there were the “punts” on high risk oil exploration or mining companies. There was a Caspian sea oil exploration company called Atlantic Caspian which was drilling for oil. Of course they didn’t find a thing and the company is no more. Fortunately I saw the writing on the wall before the end and sold out in the nick of time but I still lost money. Then there was the catastrophic investment in Asia Energy based on a “sure thing” tip, an AIM listed company trying to exploit a licence to cut coal in Phulbari province in Bangladesh. I remember the day well when I was driving home from work and listening to the BBC radio news when it announced a riot in Bangladesh with several people killed by riot police protesting against the potential open cast mines impact on their villages. Of course the price crashed. The company is now called GCM resources and is still trying to get the project off the ground 2 years on. Great lesson here, be very careful when investing in individual stocks in politically risky parts of the world. Collective investment vehicles like unit trusts/mutual funds are a far more sensible way to trade if you have a taste for the emerging markets. If I ever get a tip now where I’m told it’s a no brainer I always think to myself these days that “tips are strictly for waiters”!
I wish I could say that there was a magical formula for success as some books and newsletters claim but unfortunately there isn’t. Making money in shares is about research first and foremost. Adapting your strategy in light of current events is also very important. Who would have believed a few years ago when the banks were generating huge profits that in 2008 the Wall Street investment bank Lehman Brothers would fail and the U.K. government would nationalize Northern Rock as well as taking major stakes in many of the other British banks. In early 2008, the analysts were talking up commodities based on the “super cycle” theory which had the flawed hypothesis that prices would continue to climb into the stratosphere. Then there was the so called “decoupling” hypothesis with the forecast that the BRIC economies (Brazil, Russia, India, China) would be able to produce sustainable double digit growth even if the mature markets of Europe, Japan and the U.S. went into recession. Again, the crash in Emerging markets during the end of 2008, put pay to this assumption.
And it seems I am not alone in making mistakes. I was at a meeting with a private investor and he commented that he had bought shares in the U.K. retailer Marks and Spencer back in 2008. When I asked him why he had bought a retailer just at the time the U.K. was in recession and retailers were struggling (in fact many were going bust at this time in December 2008), he said “well they looks cheap compared to where they were before. I’m down 50% on my investment but I’m sure they’ll come good”. I respond ended well they just might get cheaper! Another short term investment turned into a long term investment!
Of course, mistakes are made, lessons are learnt and you move on. The famous Hedge Fund Manager, George Soros, who made his name by “breaking “ the Bank of England by betting against the pound and hoping it would leave the ERM (Exchange Rate Mechanism) .On Black Wednesday in 1992 the Chancellor of the Exquerer Norman Lamont admitted defeat and the pound was devalued netting Soros a reputed $1.1 billion., In a recent book called the The Crisis of Global Capitalism, he said “Most people are reluctant to admit they are wrong; it gave me positive pleasure to discover a mistake because I knew it could save me from financial grief”.
The most common mistakes I have made or seen are:
1. Not being diversified enough
Having too concentrated a portfolio in a certain sector or too much concentration of money in only a few shares can be the kiss of death if sentiment turns against it. If you put all your eggs into one basket your risk profile goes up significantly. Look at all those people who lost everything in the U.S. energy company Enron collapse in late 2001. In 2000, it claimed its revenues were over $100 billion and Fortune Magazine named it as America’s most innovative company for six consecutive years. Sure the profit manipulation by senior management including founder Ken Lay took many years to expose but thousands of investors poured their entire life savings into the company buying all the way down from a high of $90 (when insiders were selling huge blocks of stock) all the way down to virtually zero. The Enron sage is of course very sad for these people but they never should have put all their savings in one stock, especially not their pension funds, into this one company.
2. Not doing the right level of research
Most private investors are reluctant to delve into some of the fundamental measures such as debt, profitability and therefore fail to foretell potential issues down the line such as debt restructuring, dilutive share issues and the like which can hammer a share price. I have recently read a popular share dealing book written by a non professional investor and I was surprised that he felt that this sort of homework was unnecessary. I am not saying that you need to be accountant delving through the Profit and Loss Account and the Balance sheet but a lot of the web sites not can show the main measures without ploughing through pages of numbers. Take a 30 minute look at the financials and check out some other potential warning signs such as director share selling, big institutional sales, recent profit warnings.
Trading in U.S. shares has the advantage that all the quarterly earnings reports are accompanied by analyst conference calls which are available to download by private investors. Transcripts are also available on websites such as www.seekingalpha.com.
3. Being hit by despondency following some bad calls
How many potential investors buy a stock or two on a hot tip, lose a fortune and then never return to the stock market ever again as they lose half their money in 3 months. The answer is quite a few! Over the long term stocks have outperformed all other forms of investment. This is especially the case with companies that pay sustainable and growing dividends. In periods of poor stock market performance, the yield of the major indices such as the FTSE 100 can be substantial, this is the dividend payment as a proportion to the share price. You are effectively rewarded for holding a share and this payment can be higher than a savings account. Make your mistakes, learn from others mistakes and swallow your pride and move on. Persevere with the markets, it can be a lot of fun.
4. Buying shares on tips not on the basis of research
Newspapers and financial magazines can be a useful source of information about the markets in general or news on a particular stock. However, never buy or sell shares based on just what you read in these publications. Check facts, do your research and wait for the price to settle before you jump in. Remember that hot tips from the guy at the pub that says that company X is going to be taken over next week should be treated with extreme caution.
Brokerage reports are another area of caution. Many analysts are late cuttings their earning s estimates and their recommendations on a stock, How many “top analysts” were still recommending banks in 2008 when the financial crisis was beginning to play out?
5. Not cutting losses when the share price drops sharply and waiting for the rebound – “don’t let a short term investment become a long termer”
It is hard to admit you’ve made a mistake and sell a losing investment. Human psychology plays a part. It is much more effective to deploy your cash working in a company which is solid with a growing share price rather than waiting potentially for years for a dog stock to recover and waiting for that nasty negative figure to turn to a blue positive. Sometimes the losses do recover, most of the time they don’t in a sharply declining stock. Another thing to watch for is the “dead cat bounce” This refers to a very sharp decline in the price of a stock which is immediately followed by a small and temporary rise before resuming its downward path. Often this rise is triggered by short sellers buying back shares to cover their positions or small investors trying to call a bottom which is ultimately reached much later. You should try and ignore the price you paid and think in terms of I am investing my money in the best company or could it grow faster elsewhere.
6. Looking at historical prices and using this as a benchmark
Investors often look at a share price chart and use this as a benchmark of where a price should be expected to return to in the case of shares which have had a heavy fall. A great example of this was the banking sector. UK banks Northern Rock and Bradford and Bingley fell from pounds to zero in less than a year. Just because a share was at a price historically high level never means it will return there. Also be aware of share splits, where shareholders shares are for example doubled up which has the effect of halving a price.
7. Not spreading risk by buying a position all at once
It’s almost impossible to time the purchase of an investment perfectly. If you are buying a large position consider buying in blocks to reduce the risk of a sharp fall in a short period around your purchase. Although this means your dealing costs are increased, by choosing a reasonably priced online broker these can be mitigated.
8. Not taking profits or letting some profit run
Timing is everything as they say. The share pundit Jim Cramer once said “Bulls make money, bears may money but pigs get slaughtered”. What Cramer meant is that you can make money on shares going up or down but don’t be greedy and take a little off the table and bank some profits. If your shares are up 20% on your buy price, perhaps sell 35-50%, leaving your other shares to run whilst you have some nice profit in the dealing account. Conversely many investors sell everything too early. I myself have been guilty of this as the excitement of a gain takes over. Over the next few weeks, the share price has subsequently doubled again making me curse myself for not having more patience. As stated above, taking some profit whilst letting some of your profits run is a good compromise. The advantage of CFDs and Spread Betting is that you can adjust your guaranteed stop loss upwards to guarantee your profit, but if the price drops sharply subsequently your stop loss is triggered and your profit is banked. Some firms even offer trailing stop losses which automatically trail the current share price.
9. Don’t Overtrade
Sometimes patience really can be a virtue when it comes to the stock market. Sometimes it pays to leave the portfolio alone. Research shows that the most successful traders have periods when they do little or no investing. Maybe there just aren’t any really good opportunities, the market is stuck in a range which makes it neither showing value nor over expensive so both long and short investors stay on the sidelines.
10. Don’t take internet bulletin boards too seriously
Watch the bulletin boards on iii.co.uk and advfn.co.uk with interest but don’t base your investment decisions on what’s said on them.
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