Tips and Strategies for Trading Shares
This section deals with some known stockmarket strategies which have performed, for short periods, above average expectations. It is important to remember that no stockmarket strategy can be consistently successful, or everyone would adopt it causing share prices to fluctuate in a way which would undermine the original strategy. By far the commonest strategies involve the identification of individual 'under-valued' or 'growth' shares. Several general strategies are listed below.
High Yielding Stocks
Mention was made earlier of the strategy of buying shares only in those companies which had the highest yields and whose share price is higher than it was 12 months previously. Lists of stocks meeting these criteria are published six-monthly by the Investors' Chronicle and the strategy is claimed to be quite successful in giving above average returns in the medium term.
Recovery Stocks
Investment in a wide range of recovery stocks often gives good performance in the long term, where the spread of risk enables several winners to offset losses from a few losers. M&G's 'Recovery Fund' has been one of the world's most successful unit trusts.
Average Down
This is the name given to the process of buying more shares in a company as it falls in value, in order to maintain its overall position in the investor's portfolio.
For example, you buy 1,000 shares at 100 pence (total outlay £1000, neglecting dealing charges). Two months later you buy 1,000 more shares at 50 pence each (an extra £500). Two months on from that you buy 2,000 shares at 25 pence each. The total value of your shares is now 4,000 X 25p = £1,000, so that the value of the company in the portfolio remains the same.
If the company recovers to a value of 100 pence per share, then you have made a useful profit. In this example, the profit is 4,000 X 100p minus 1,000 X 100p minus 1,000 X 50p minus 2,000 X 25p which equals £2,000.
However, if the company goes bankrupt, which is clearly on the cards judging by the way its share price is collapsing, you have spectacularly sent good money after bad. Never, ever, average down, unless you are sure that your view of the company is right and everybody else's is wrong. Remember that the professionals rarely average down.
Success Breeds Success?
One old and well-tested strategy is called the 'Simple Reversal System'. It says, substantially, that in any four week period a share should be bought when its price has risen above its high prices of the previous four weeks, and sold when it starts to fall below its low prices of the previous four weeks. This is one of the very few strategies which has been objectively tested and found to deliver a good performance relative to the relevant stock market indices. Also it represents an unusual case where the effect of everyone joining in is to reinforce the correctness of the strategy. However, it has always seemed to me to be a very risky game to buy a share when it rises above its previous high value, since this invites a sudden fall in its price. This system is well known to have a potential for creating occasional large losses, which can be checked by the use of a 'stoploss' system.
Pound-Cost Averaging
Owing to the difficulty of getting timing decisions right when buying into the stockmarket, some authorities advocate pound-cost averaging. This strategy means buying a fixed sum of stock at regular, short intervals, regardless of how well the market is doing. This procedure inevitably means that some shares will be bought too expensively, others very cheaply. However, more shares will be bought when they are cheap.
A possibly superior strategy is to buy a different line of stock at regular intervals, but to try to pick a stock which appears to be undervalued at the time of selection. Invest at once Research has shown that it is usually better to invest a lump sum all at once, rather than piecemeal over several years. This is because markets tend to rise over time.
Avoid Losers
The strategy of diversification of shares is intended to enable many winners to offset a few duds. An alternative strategy is to avoid picking losers in the first place. If you have a portfolio of shares in ten companies, then one bankruptcy has to be offset by gains of 11 per cent in value of all the other stocks. So avoiding one loser has at least the merit of being more efficient than trying to pick nine winners.
A strategy of 'buy the index, less losers' can be expected to bemore successful than copying the index over long periods. It means buy a diversified range of shares (more-or-less to mimic the FT30index) while avoiding the purchase of those companies that appear to be consistent losers.
Do Not Recover Original Price
Many private investors adopt the strategy that they will not sell shares for less than the price they originally paid. This is most unwise, since you can be locked into a dud investment for years, or even see it decline into bankruptcy. Always be prepared to sell at a loss, if you think the money could be invested more profitably elsewhere. Institutional investors never seek to recover the original price.
Stop-Loss Policy
Some authorities suggest that if the value of a share falls after you have bought it, you should automatically sell. Thus you cut your loss as soon as the price falls below the level you determined before buying (typically after a fall of 15 per cent).
This practice is known as a stop-loss policy and guarantees that you will never lose more than 15 per cent of your original investment. As the saying goes, 'the first loss is always the easiest to bear'. Of course, you feel pretty silly if the share price then rises again! A stop-loss policy is probably best implemented relative to the market as a whole. That way you do not have to take action against your newly-acquired shares just because the whole market has given a sudden lurch downwards.
However, if the relative loss is stopped even despite a general fall, the money must be re-invested in the market to minimise the original loss.
There are various theoretical disputes about the value of stop-loss, mostly based on the fact that the investor guarantees himself a loss by selling instead of hanging on until the price recovers.
All Investors get Bitten Once
It is a fact of life that nearly all new investors start buying shares after stock markets have been rising too long and the newspapers are full of stories about how much money has been made by those already invested. Nearly all investors, therefore, suffer an ensuing bear market while still 'green'. The most important thing is to sit tight and wait for the market to recover, rather than to sell out in a panic at the bottom of the bear market.
Sell Underperformers?
Some authorities recommend that stocks which are underperforming relative to the market average should be sold, and the money reinvested in stocks which are performing well.
However, it has been shown that this year's underperformers often outperform the average in the following year, while star stocks tend to do worse. The reason is fairly obvious. Companies which are underperforming will take radical steps to do better, or will become the target of bids, while the growth of the hot stocks tends to fall away.
Disagree
An oft-stated stockmarket adage says that when everyone agrees on a course of action, do the opposite (the 'contrarian view'). Unfortunately, it is rare that market analysts ever agree about anything.
Guaranteed Strategies
A new, innovative strategy was made possible by one-time high interest rates. The investor is guaranteed to receive most, or all, of his money back after a year or two. In addition, he may receive a considerable bonus.
The secret is that some 90 per cent of the investor's cash is placed in bonds or other high interest vehicles. The remainder, some 10 per cent, is used to buy warrants. This is known as a 'Cash and Calls strategy'. If the market goes up, the warrants increase rapidly in value, giving a geared appreciation in capital value and a good return to the investor.
Should the market fall, the warrants become worthless but the high interest paid on the 90 per cent of cash ensures that the investor at least gets his money back.
A modem alternative is for the guarantor to use the dividend income from the shares to purchase a 'put option' as insurance against a market collapse. This is known as a 'Stock and Put strategy'. The value of the guarantee then depends critically on whether the writer of the put option (the final guarantor) can meet its obligation in the event of a market collapse.
These strategies have been extremely popular. However, they can only be expected to succeed as long as interest rates remain high. As with all lower risk strategies, the long term financial return will usually be less than that from a direct investment in shares.
