10 Key Lessons for Investors
and Traders
This could
also be called: Beware
the Share Market Bears!
A brief summary of
why we should beware the bears
("The 10 Key Lessons for
Investors and Traders")
Lesson #1 - The buy-and-hold strategy has expired!
Investments can fall as much as 90% or
more! There is a long list of examples of companies
that plunged in
value by 70%, 80%, and even 90%. And some of them went under in the big
GFC with 100%
of their value gone.
Blue chip stocks can disappoint.
In any of the periodic financial crises that come along from time to
time (perhaps as frequently as every 4 years in the good times), it
might even be worth divesting of blue chip stocks to preserve capital.
Lesson:
The buy-and-hold strategy has expired!
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Lesson #2 - Priority one - Preserve the capital!
Blue chip stocks are
not safe havens and
may not maintain their capital value. Capital-protected products exist,
but their effectiveness can be questionable - be sure to read the fine
print and understand the costs of the capital-protection guarantee.
Keeping a falling investment just to receive the dividend income stream
might not be as good as liquidating the asset and redirecting the
capital to another investment.
For share market
investments, consider using a Stop
Loss approach to preserve capital, and prevent it's
deterioration.
Lesson:
Priority one - Preserve the capital! Consider selling a falling
investment in order to protect the investment capital.
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Lesson #3 - The Big Picture - maintain the perspective
Don't get hung-up by
the short-term news and noise in the markets - it is very distracting.
Remember, the market is
like an elephant.
Step back and look at the bigger picture, but beware of the people who
tell us that our stock market investments will make returns in the
long-term (they are referring to the very long term - 30, 40 years or
more).
Also beware of the
arbitrary baseline dates that are used to measure and report on
performance (eg. year-to-date, or this quarter). These can be very
misleading. Step back and look at more realistic scenarios and time
frames (eg. from market peaks, and troughs).
Lesson:
Remember the big picture to maintain perspective.
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Lesson #4 - Markets, stocks, property all run in cycles
A number of different cycles are reputed to exist,
including:
The challenge for all of us is to be aware of these
cycles, and to
anticipate them so that we don't get caught up in them.
See more details about investing in cyclical stocks.
Lesson:
It can be very useful to be aware of the cycles, and of over-the-top
prices.
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Lesson #5 - Stock market
corrections - they happen more often than we care.
Markets rise over time (over the very long term) -
this cannot be
disputed. One web-based sample is the Vanguard chart of the performance
of a $10,000 investment over time (see it here). We can see charts of
the US market going back many decades, but for the Australian market
only since 1980 (as we had state-based
stock exchanges for decades prior to that).
Analysis
of the bear markets (more than 20% fall) and corrections (more than 10%
fall) on the Australian market shows that they occur about every 3 to 4
years. So the next one is not far away. And on two occasions, a bear
market has seen a market correction occur within 3 years, and before
new market highs are reached.
The research for this led to
a detailed
analysis of Australian Bull and Bear Markets over two decades.
Lesson:
Stock market corrections do happen, too often than we would like, and
the bears can demolish investments, so be prepared to protect them (the
investments, not the bears).
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Lesson #6 - We can "time the
market"!
Despite what many finance industry professionals say,
we can "time the market". It is possible.
"Timing the market" refers to the situation where we carefully
time our entry into the market, and we time our exit from the
market. We do this in an attempt to maximise profits
and minimise losses. The alternate view is to "spend time in the
market"; but see Lesson #1 and more for comments on this.
Some experts convincingly say that it is not
possible to "time
the
market". They say that if you try to time the
market, and if you miss out on some of the "best" days in the market,
then your returns are limited. What they don't tell you is that it
really is possible to avoid the
"worst" days in the market, and to avoid significant losses. In this
way you can potentially have much better returns.
Frank Watkins (in Perth, Western Australia) sums it up
nicely in his book "Exploding the Myths".
And other famous traders / authors reiterate the same stories.
Lesson:
Many people do successfully "time the market" - it can be done!.
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Lesson #7 - Financial advisors, brokers, bankers.
Don't forget that the
finance industry professionals provide
advice because it is their job. And if the advice is not sound, it
won't affect their take-home pay, nor their own
investments. When
it comes to financial advice, your own financial advisor might not
be 100% right, 100% of the time. Sometimes a second opinion can be
useful.
See a short list of useful questions to ask your financial adviser.
Lesson: Don't
believe absolutely everything that you hear. Healthy
scepticism is, well, healthy.
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Lesson #8 - Leverage - beware!
Margin lending can be safe
over the long term under some circumstances (such as in bull market
conditions); but it can quickly destroy wealth in bear market
conditions. Investment products such as CFDs (Contracts for
Difference), and other geared products can do likewise.
Some people take out a margin loan, and borrow funds to the max so that
they can highly leverage their available capital. Some people use the
borrowed funds to buy an investment (like shares) for the long term.
And then they park the investment and forget about it. And
they might pre-pay a year's worth of interest expense to gain a tax
advantage.
Lesson:
Leverage - Beware! It might work in a raging bull market. If you don't
understand the rules of the leverage game, then don't play the game.
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Lesson #9 - Chart reading can be very useful.
It is possible to anticipate bear market conditions,
and then to pro-actively take action to protect investment capital.
Share market price charts contain a wealth of information about the
underlying mood of investors and traders in the markets. Consider using
charts and technical analysis tools like:
See more details on this topic according to Brainy's
Weekly Market Analysis, and more details on technical
analysis.
Lesson:
Charts and technical analysis can be very useful.
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Lesson #10 - Risk/Reward - Understand and respect it
By understanding the key notions of risk and reward,
we are able to sleep more easily at night. Ideas such as "the amount at
risk" and The 2% Rule, and limiting the amount of a portfolio that is
exposed to given investments, or given sectors or asset classes.
Optimising the position size can be very useful.
Calculating in advance the amount to be put "at risk" for a given
amount of likely "reward" enables us to calculate the Reward to Risk
Ratio, and strive for a value much greater than 2.
Lesson: Risk/Reward
- Understand and respect it.
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And beware