Learn the rules if the trading game tempts you
▶ There are aspects about stock and share movements wannabe investors need to know. Harvey Jones reports
Have you ever felt the urge to trade individual stocks and shares? Maybe a colleague handed you a hot stock tip that could make you brilliantly rich. Or perhaps you read about a tech start-up that’s the next Apple. Or maybe you simply had a hunch that a company was going to fly.
Make the right calls and you can earn big money. If you had invested $1,000 when retail behemoth Amazon floated in 1997 at just $18 a share, for example, you would have $92,611 at today’s price of $1,677. Who wouldn’t want a piece of that?
The downside is that you can also lose a lot of money. If it was easy, everybody would be doing it.
If you still reckon you can beat the market and make a million, then read on.
Trading stocks is easy. You can do it quickly and cheaply online using platforms such as Internaxx, Interactive Brokers, Saxo Bank and Swissquote. Register, fund your account with a debit card and off you go.
Gordon Robertson, director of financial advisory group InvestMe Financial Services in Dubai, says online stockbrokers have revolutionised investing, but one thing has not changed.
“Fortunes can change dramatically and if your chosen stock crashes to zero you lose all your money.”
Clawing back losses is not easy either, as the maths is against you. “If a stock falls 20 per cent, you need it to rise 25 per cent just to break even, says Mr Robertson. “If it falls 50 per cent, it has to rise 100 per cent.”
There are several things you can do to minimise the danger, though. First, invest in a spread of at least 10 or 20 stocks, so if one or two fail, others may rise to compensate.
Mr Robertson says you can further protect yourself by setting up a trailing stop-loss. “This will automatically sell a stock if it falls, say, 20 per cent. As it moves up, so does your stop loss, which locks in your profits.”
The danger is the stock drops 20 per cent, triggering that stop-loss, then rebounds 30 per cent by which time you have already sold.
A common rookie mistake is to buy on past performance, picking stocks that have shot up just before they crash.
Steven Downey, a certified financial planner at Holborn Assets in Dubai, recommends paying close attention to company valuations to avoid paying more for a stock than it is worth, and this is a tough skill to learn.
“You may have bought the best company in the world but won’t make money if you overpaid,” he says.
The most popular valuation method is the price/earnings ratio, which divides a company’s share price by its annual earnings. A stock trading at 15 times earnings is generally considered fair value, below that looks cheap and above that expensive.
Sites such as Bloomberg will show this calculation for most major stocks, although it isn’t foolproof. A stock may be cheap because nobody wants it.
When trading shares you are pitting your wits against clever and well-resourced professionals, and newbie investors have a habit of overrating their abilities.
Stuart Ritchie, director at independent financial advisers AES International in Dubai, says success demands effort and commitment. “You must dedicate yourself to stock research, market observation, charting techniques and other methods.”
Even then, a favourable outcome is still not guaranteed. As many as nine out of 10 professional fund managers fail to beat the market consistently, according to the SPIVA US Scorecard from S&P, so what makes you so special?
Mr Ritchie says the vast majority of ordinary investors should not even try, and instead buy a spread of mutual funds and low-cost exchange traded funds. Hugely popular ETFs simply track their chosen index and have rock-bottom charges so you keep most of the profits to yourself.
ETFs will never beat the market, but nor will they underperform. “They give you a diversified approach by exposing you to hundreds, or even thousands of different companies,” Mr Ritchie says.
This wipes out the danger of investing in a company that goes out of business and takes all your money with it.
Tuan Phan, a board member of SimplyFI.org, a non-profit community of UAE investment enthusiasts, loves investing but shuns individual company stocks.
“I do not know of a single compelling argument for the average investor to only buy single company stocks, given the ease of low cost mutual funds and ETFs,” he says.
Holding individual company stocks pretty much guarantees that you will suffer a catastrophic loss at some point, he adds. “Facebook, Apple, Amazon and Google owner Alphabet may look dominant today, but history shows even the biggest companies can fail. Remember Kodak Eastman?”
Amazon chief executive Jeff Bezos recently made the same point, warning employees that Amazon is not too big to fail, saying: “In fact, I predict one day Amazon will fail. Amazon will go bankrupt. If you look at large companies, their lifespans tend to be 30-plus years, not 100-plus years.”
The figures back him up. Only four companies on the S&P500 were around 100 years ago, and spans are shrinking.
The average tenure fell from 33 years in 1964 to 24 years by 2016, and is forecast to shrink to 12 by 2027, research from Innosight shows.
Even the most established company is vulnerable, Mr Phan adds, noting that utility giant General Electric, a founder member of the Dow Jones Industrial Average 110 years ago, has just crashed out as its share price tumbled from $32 in July 2016 to less than $8 today, losing 75 per cent of its value.
He says the golden rule of investing is “diversification, diversification, diversification” and betting too much on a handful of stocks could wipe you out.
“The risk is particularly acute for those with employee shares. Many face financial ruin when their company goes to the wall and they lose both their job and their savings.”
Steve Cronin, founder of DeadSimpleSaving.com, a non-profit site that helps people invest their money sensibly by themselves, recommends sticking up to 90 per cent of your invested wealth in ETFs.
“Trackers are great because every index is self-cleansing. Bad companies fall out and are replaced by more promising ones.”
View trading individual stocks as a bit of fun and never chance more than 10 per cent of your portfolio.
“If one of your stock pick booms then rebalance your portfolio to make sure it is still worth less than 10 per cent of your net worth, in case it crashes back to earth.”
This will help you hang on to your gains and prevent you from getting greedy, Mr Cronin says. Investing in stocks and shares exposes you to perhaps the two deadliest human emotions of all – fear and greed. Mastering these is the biggest challenge of all.