Beware of swimming with the sharks
Like many Canadians who tire of our winter weather, I took an early reprieve and just returned from hawaii, where there has been an abnormal amount of shark attacks this year.
Being the analytical person I am, I sought out the advice of locals before entering the water. The most common response was to respect the ocean and follow some simple rules, such as not going out in murky water or at dusk and dawn, avoid wearing shiny jewellery, and not panicking if you see a shark.
All of this got me thinking that there are similar rules to avoid getting bitten while venturing out in the markets. Unfortunately, many investors who have lost money over the years and/or those scared by volatility have decided to stay on the beach and reallocate their savings to bonds for their perceived safety.
As a result, they are missing out on some great opportunities being offered by the stock market and may fail to meet their objectives in this low-interest rate environment.
While there are clearly risks when investing in equity markets, they can be mitigated by heeding a few simple rules, not unlike the ones I received on my trip.
First, respect the ocean or, in this case, the market by staying humble and not getting too confident in one’s investment prowess. Overconfidence results in excessive risk-taking, such as having too high a concentration in one particular stock or sector.
Second, don’t go out in murky water. Periods of uncertainty, such as the months leading up to the financial crisis of 2008, are not times to increase risk.
Third, don’t enter the water at dawn or dusk. In many cases, highfrequency traders (hFT) and exchange-traded-fund rebalancing can cause large moves at the open and close of the market. hFTs are also notorious for causing large moves in a stock or commodity either right before or immediately following a particular event. Therefore, we recommend being patient when entering a trade, using limit orders and staying out of the market at the start and end of the day.
Fourth, don’t wear shiny jewellery. In other words, avoid showing off and exposing your trade. Given the illiquidity of certain equity markets, it doesn’t take much at times to move a stock. This is where a professional trader can help layer in a sizeable order or off-load a large position while minimizing the impact on the stock. Also, always keep your trades close to your chest, since it’s no one else’s business what you own.
Finally, if you happen to see a shark in the market water and get bit, don’t panic.
While this is easy advice to give, it can be difficult to follow when it actually happens. It can help to have a plan in place to take the emotion out of the situation. For example, when the fundamentals of a stock rapidly deteriorate via a surprise quarterly update, it may mean having to take the loss and move on rather than staying in the water with an open gaping wound.
A little proactive planning by an investment professional can help develop a risk-management plan for your portfolio. While staying on the beach is no doubt the safest action, it’s worth taking a good swim every once in a while to cool off, but also to enjoy the bounty of the ocean.