In this month's newsletter we're going to be looking at why in our view most investors should invest in the market and not try and short term trade. We'll also be looking at where the markets are likely to be heading in 2006.
Why Knowing & Respecting Your Time Frame Is Critical
Or to put it another way, if you're an investor in the market - attempt to trade the short term fluctuations at your peril.
One of the greatest problems that investors face is keeping their eyes on the long term picture and not being diverted by the blitz of short term media coverage and movement. For example, it's all too easy to get excited about a market when it's moving higher predicting ever higher prices. Watch CNBC or read the financial papers and almost every pundit will be forecasting higher prices on the back of recent strength. But they'll soon change their tunes predicting lower prices as soon as 1 or 2 days of weakness shows up.
This short terminism is best illustrated in football when if a team like Manchester United lose 2 games on the trot the newspapers will be full of 'end of an era' or 'can United ever win the league again?' type articles. But then, after a couple of good results the same papers will report that 'United are likely to be the super team for the next 10 years, almost unbeatable'.
Why Sort Term Trading Is So Destructive (for the majority)
Most people are investors in the stockmarket. They buy ABC stock in January with the idea that it should be a top performer over the year. If the stock's price is to rise as predicted then it won't obviously do so in a straight line, there will be swings both up and down with an upward slant. But it's when these same investors get sucked in by the short term moves that most get into trouble.
For example, ABC stock is priced at 100p and over the year will double to 200p. The first few months it might move steadily to 115p before a quick spurt takes it to 140p. Then a decline back to 125p, another move to 150p and then back to 130p etc, all the time going generally higher.
The successful short term trader will attempt to profit from all of these moves, so whereas if the investor buys at 100p and sells at 150p, 50p is all he can make. But the short term trader might actually make 90p in profits from taking advantage of the short term swings. However, the short term trader could actually lose money as well or make hardly anything as he gets chopped around, ie buying/selling at the wrong time. This is an important point to take on board.
The final problem for the trader who has a long term outlook on the stock but is trading it short term is that he could easily miss the real meat of the price rise. He buys at 100p, sells at 120p waiting to re-enter at 112p but the stock only moves back to 115p before blasting off to 150p and above. The short term trader is left cursing his own greed and often whining 'why was I trying to be so clever, all I had to do was buy and sit on the damn stock'.
Know Your Limits
For most people short term trading is something they should not attempt because it is incredibly hard to pull it off in a consistent manner,. It is a fact of the markets that most short term traders fail to make money overtime. Look at your past results, are you getting better profits from long term positions and/or losing with short term ones? If so, know your limits and realise that some of the best investors worldwide admit they are useless at short term timing the market and vice-versa.
How To Avoid Getting Caught Up In The Swings
- Concentrate on the bigger picture and realise that there will be swings both ways
- Don't worry too much about the direction of the overall market, ie the FTSE 100. If you've done your research into an individual stock then it will likely act independently as to what the overall market is doing
- Don't watch more than 10 mins of CNBC a day, most of the commentators there are doing nothing more than marketing, stocks, themselves and their respective firms
- Be wary of following the commentators in the daily press as well, they are as short term as those appearing on TV
- Finally, don't look at your stock prices on a daily basis, try and do so only every week. Does it really matter that your stock price rose or fell by 1%-3% today, yesterday or last week, especially when you are looking to hold for many months and maybe even a year or so? In our view most of the daily movement is nothing more than background 'noise'
Concentrating On The Long Term Often Pays The Best Dividends
One of the less hard ways to make money in the stockmarket is to focus on the long term trend and then do one of two things;
- Buy weakness, ie reactions down from a high, and
- Sell into strength to take profits
Most people try and do things the other way, especially the first point. They buy and get all excited when prices are at their highest scared that they're going to miss the move. But in reality if the stock and sector is strong then there's better than an 75% chance you'll be able to buy at a cheaper price. Just wait for things to calm down and buy a reaction down from the recent highs.
Alternatively another good strategy is to buy say 25% of your total investment value at the market and then look to increase the position if/when the price declines. That way you're always on board should the stock take off.
Taking profits is also important and should be done only on strength, preferably when they market makes another all time high. Another great way to take profits is if the price starts to really accelerate on the upside, perhaps moving 5%+ or more on a given day. This can often signal what technical analysts call 'exhaustive buying' and can signal an end in upside price movement.
A recent good example of this would have been in the Gold market in December 2005 when as it went through $500 it only took a couple of days to reach nearly $550. That move was so uncharacteristic that gold investors should have taken profits on at least 25% of their positions. In this case price did move back down to $490 but so what if it didn't? If it had blasted off again to $600 the gold investor would still have been very happy indeed to be sitting on his 75% investment and only a greedy fool using hindsight would have complained about selling at around $540 or so.
