Points one and two (Don't buy into companies unless you know the debt level and Don't buy into companies with high debt levels) cannot be overstressed.

The main cause of really bad sharemarket losses is company failures, and these occur when the company's creditors realise that debt levels have got out of control and decide that their best chance is to appoint an administrator, receiver or liquidator to try and recoup their money.

Liquidators are generally like bulls, no...brontosauruses, in a china shop and often any hope the company had of trading its way out of trouble disappears the moment the administrator gets their foot in the door and starts flogging off assets at garage sale prices. Certainly a liquidator's loyalty lies with the creditors of failed companies, not the shareholders, so keeping the company viable as a going concern is not their highest priority. Getting cash for the creditors (of which they are one) tends to be paramount. Creditors are often not shareholders in the company and are likely to be banks and financiers, or trade creditors owed money for inventory or work. Shareholders are unfortunately like untouchables in the pecking order of failed businesses!

Point three (Give your selection a reasonable amount of time in which to perform) refers to an oh-so-common scenario. The intrepid plankton gets a hot tip and jumps in with great excitement. A few weeks go by and nothing happens, so punter plankton realises the money could be better used on some other activity with quicker gratification profile. Another month goes by and stock suddenly soars, quadrupling in the space of two weeks, but alas, without punter plankton on board.

The point is, why should a stock suddenly surge the day after you buy in (and the day after someone else sold out?) It may have been around its current level for months or even years, so be reasonable. Don't expect stocks to behave as if they owe you a living at everyone else's expense.

Point four (Never allow your bids or offers to be affected by fear of upsetting a broker or looking stupid) is one you may never find relevant, but can be very important under certain circumstances. You may have good reason to believe that a stock is going to fall to a certain level, or only be interested in it at that level. If you place a bid at that level some brokers may tell you, 'I don't think you'll see any action at X price, how about we go in at Y price?' The investor may feel embarrassed or guilty about looking like a tightwad or wasting the broker's time and may end up being talked into paying too much.

Or the investor may place a sell order at a high price, notice that the market is rising strongly, but feel too intimidated to ring and cancel the order. Don't feel that way! Failure to follow your instincts could be very costly and remember, your broker, however nice he or she may be, has a vested interest in turnover and will be naturally less inclined to haggle than you are. Stand your ground. Your broker is not going to starve, but you might. Your broker is working for you.

Point five (Try to generally buy stocks at historically low levels in spite of market sentiment) looks like an exercise in the bleeding obvious and yet, if you look at a share price chart, no matter how precipitous the highest peak, some unfortunate people thought it was a great buy at just that moment. This point is quite controversial, as technical analysts usually recommend buying stocks on an uptrend, and an uptrend takes time to identify, by which time the stock is not usually near historic lows. Nevertheless I believe this a good rule.

It is usually not a good idea to buy a stock that is consistently falling, even when it reaches an historic low, because it may well be in the process of setting a far more enduring P.W. (personal worst!) However, a stock that has found a long term support level and has bounced along that floor for some time is very often a good investment for the patient punter, provided it has some other attractive feature going for it such as endorsement from a friendly Shark who can be trusted.

Point six (Try and buy in sectors of the market that seem undervalued or out of favour ) may be a little controversial in that good money can certainly be made out of the latest Tulip frenzy or South Sea Radio craze. However, in the speculative sector especially, upside is always there, but minimising risk is a much harder task.

One good thing about being a countercyclical investor is that even if you are inexperienced in the market per se, you might have a talent for picking economic trends or identifying the next boom sector. It did not necessarily take a brilliant share trader or clairvoyant for instance, to guess a few years before it happened that internet and technology stocks would at some point become all the rage.

Point seven (Don't overreact to blind panic - Be prepared to sometimes be brave) refers to the old adage, 'buy in gloom, sell in boom'. The trouble is, it is actually terribly difficult to buy in gloom, as there are always 101 good reasons why everything appears doomed and nothing will ever be any good ever again. Hence the comment about panic and bravery.

The final flourish of a falling market is often blind panic, frequently bouncing back a bit and then staying flat for some time and history shows that in general (though not always) it is better to be buying at such times than selling. One rider is that if you have been foolish enough to buy into a 'hot' market and suddenly a market crash starts to occur, then get out fast! Stocks were probably grossly overvalued and usually do not correct to a sensible lower value in one day, so an early exit will usually preserve capital. Also, markets always overreact, so if you can get out early it is usually possible to buy back later on when the overreaction has become obvious and stocks are much cheaper. Point seven assumes that you have followed the other rules and made what appears to be a hard headed investment based on fundamental value.

Points eight and nine (Never stray too far from the fundamentals - There are lots of stocks to choose from and When considering fundamentals, believe the bad but double-check the good) both assume that you will be looking at some of the fundamentals of the companies you buy into. There are other ways of investing, but learning to understand some of the basics of balance sheets, p/e ratios, management quality and so forth will certainly repay the effort.

The important point is that with many hundreds of companies to choose out of it is not necessary to make serious compromises of your investing principles in order to find a suitable stock.

Point ten (When deciding where to put your eggs, the quality of the basket is more important than the number of baskets) refers to the old adage, 'don't put all your eggs in one basket.' This is sensibly motivated, but for most people their money in the sharemarket is not the only basket anyway. They have a house, or superannuation, or simply possessions, as well as their sharemarket holding.

If you carefully weigh up various stocks and one or two appear head and shoulders better than the rest in terms of value, don't be scared to put all your sharemarket money into those. Why water down your exposure with stocks you expect to perform worse? It may be wise to keep some sharemarket funds in cash in case another great opportunity comes along, but don't buy a spread of stocks purely for the sake of diversity if one or two seem far better after sensible analysis than the others (Naturally brokers think it's a good idea though, spending $30,000 on 5 stocks generates a lot more brokerage than spending $30,000 on 1 stock.)

Point eleven (Be prepared to quit the market altogether sometimes) is another thing your broker will rarely, if ever, tell you. But timing is perhaps the single most important factor in playing the market successfully. (See below) At certain times it is simply bad value to be in the market, as the odds of it falling are significantly higher than it rising. When the market goes into a tailspin, even good stocks are likely to fall.

Sometimes it is not practicable to exit the market completely for taxation reasons and you may be a retired person living off the fully franked dividends of blue chip stocks whose price does not matter to you as you are never selling. That's fine of course. Most investors however, do care about capital appreciation and should occasionally be prepared to exit an overheated market altogether and buy back in later.

Point twelve (Don't rely on formulaic rules or systems from other traders, books, or indeed websites such as this!) is one that is sure to arise at some point if you become a regular market player. Someone will tell you about a charting system or some other formulaic method that is practically infallible. Coincidentally, all such systems seem to have one thing in common, they entail paying money for them, despite the fact that the person who discovered the system clearly must be a billionaire from using their own infallible system.

Do any of these systems work? Sure they do. We simply recommend that before you send money for any system devised by someone who used it to make a basketful of money, you just get them to send a photocopy of their tax returns from the years when they used it to make their fortune. It's not much to ask and once they've done that and you've verified the information, we see no reason not to give it a try.

NEXT ... Timing

 


 

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