Friday, July 8, 2011

Investment advice as a newbie

Many years ago, I started a thread entitled "Investment lessons learnt this year and advice for newbies" on a now-defunct investment forum called WallStraits. I thought it was lost but I retrieved some of the posts which I wrote 6 years ago on another blog (http://whereiszemoola.blogspot.com/).

It is quite embarrassing to talk about my own performance in my first year as a retail investor. The year was 2004 and I suffered stomach-rending losses in a year when the Straits Times Index rose 17%. To lose money was bad enough. To lose money when everyone else seems to be making it made it far worse. To top it off, the losses came in a year of extreme hard work with great passion. I had to really question myself ... am I stupid?

Below were my thoughts written 6 years ago to fellow newbies as I pondered over my failure in my first year of investing as a newbie. The losses were caused by a large, concentrated position due to repeated averaging-down in a China S-chip stock.

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Investment lessons learnt this year and advice for newbies
When I just started investing late last year, this was the first investment website I stumbed upon. I was greatly influenced by its FA bent and the eloquent arguments from fellow forummers.
I have some advice for newbies from personal experiences as a newbie.
There are certain practices advocated by FA(fundamental analysis) proponents that newbies need to be careful of. (If you are a grandmaster like d.o.g or Sage, you can ignore the warnings below. I need your advice more than you need mine. This post is more for the benefit of newbies)
The first one is with regards to averaging down. FA proponents like to say when the share price of one of your holdings goes down, you should buy more because it has become cheaper. So, when prices are depressed, you should be happier because you can buy more of the same good thing more cheaply.
You could try that if you have sufficient grounds to be so confident of your investment. But if you are just starting out as a newbie like me, please cut your losses and don't compound your mistake. You make a purchase, the share price goes down -> probably you made a mistake. Who are you, little junior, to argue against the market? If you are a newbie, assume you are an idiot waiting to pay school fees and don't average down. Cut your losses!!

Perhaps the most valuable advice that I have received from FA proponents is to know your investments very well and avoid those which you only vaguely understand. If you know your investments with the depth that Warren Buffett has with his, then you can average down with less worry.

One of my mistakes was to make investments based on superficial understanding. True, I read prospectus, annual reports and even taught myself accounting so that I could understand financial reports better. Most of my investments were made based on favorable financial ratios without a deep understanding of the business nature. I did not try out the company's goods and services. I don't know if the company's customers, employees, suppliers are satisfied with it.
My main fault as a newbie was to be over-confident. I thought after reading and learning so much, I was ready. I thought I could be as good as the masters and followed one of their strategy -- concentrate your eggs in one basket and watch that basket carefully. Once again, I reiterate that such a strategy is meant for the masters. If you are an amateur, it is safer to assume that you are an idiot and to protect yourself from stupidity, please diversify. By putting all your eggs in one basket, you may have fatally injured yourself by catching all the falling knives with one hand.
Some FA practitioners do not have a stop-loss policy. They use a similar argument - if a good thing becomes cheaper, I should buy more instead of selling it away.

The TA(technical analysis) approach "Cut your losses and let your profits run" is worth considering. It is a safe way to protect your capital. Sell after your losses reach 10% of the intial capital outlay no matter what. After all, he who fights and runs away may live to fight another day. In fact, by adopting such an approach, you could protect yourself against CAO (China Aviation Oil), Informatics and Auston.
Unfortunately, I did not follow the advice above. I waited until fundamentals have clearly decayed before thinking of selling. In the meantime, I continued to average down as the price slided down. When the financial report was out, fundamentals did look bad but ALAS!!, it is too painful to sell now.
This is one of the problems with FA. You can only make decisions an a quarterly or half-yearly basis which by then, the price may have slid to a psychological unacceptable level to sell.
FA proponents like to say making decisions based on price movement is nonsense. Say, the management has been trying to hide important fundamental data from the financial reports for as long as they can. The silent accomplices - auditors and independent directors - who are on their payroll prefer to close one eye or both eyes as long as they have ready excuses to plead ignorance and other disclaimers when the situation implodes.

The poor FA practioner will continue to average down, thinking that he is profiting at the expense of the foolish irrational market. Meanwhile, the insiders are selling the stock down to the sucker - that foolish guy averaging down.

In such a situation, the TA practioners will be safe. Having observed that the price has been in a downtrend caused by insiders selling down, they would have already sold out before the bombshell explodes. In the cases of CAO, Informatics and Auston, the price chart has shown an obvious downtrend before the explosive truth was out.
Are there any other advice and warnings fellow forummers can share with future newbies?
PS: I do not want to get into a TA vs FA debate. If any FA proponent thinks I am wrong, please point it out objectively without making personal remarks. I am still learning and am considering using a mixture of both FA and TA at the moment.

7 comments:

  1. Not just newbies, even seasoned retail investors who have limited time and resources in analyzing companies should also think twice to keep average down.

    Read? Some articles n Average Down

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  2. Yes, many of us have all learnt this lesson the hard way. You hit nail on head when you say we should not base action on superficial knowledge and we all know china shares are particularly dangerous. But who has superior knowledge? Even the experts got it wrong with the bank stocks when the crisis hit incuding our own Temasek Holdings. Then they got it wrong again when market recovered and sold winners such as BOA instead of losers such as UBS. Then again, you share about TAs but this is specific knowledge which lay investors in market doesnt have. Guess it's about risk management and we all know that Blue Chips have less wipe out risk than penny stocks and blue local companies have less likelihood of being wiped out or being fraud than China hit and run stocks.

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  3. I have a web site where I give advise on penny stocks and stocks under five dollars. I have many many years of experience with these type of stocks. If their is anyone that is interested in these type of stocks you can check out my web site by just clicking my name. I would like to take a moment to talk about low price stocks not classic penny stocks or stocks under one dollar the term most people most often think of when the word penny stock is used. Their are companies of really decent quality trading under five dollars’ but for every one company trading under five dollars that is of decent quality their are maybe ten of poor quality. So the really big difference between those investors that are tremendously successfull when it comes to investing in low price stocks and those investors that lose enormous amounts of money investing in stocks under five dollars’ is having a great deal of knowledge and experience when it comes to low price stocks’ or having a total lack of knowledge and experience when it comes to low price stocks. Finding quality stocks under five dollars requires a lot more research than finding a decent stock above ten dollars.

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  4. Hi Createwealth8888 and Anonymous at July 13, 2011

    I think the key in averaging down lies in being honest with ourselves. Do we really know enough about the stock to justify averaging down? If yes, then doing so is the right thing to do because it makes sense to buy more of a good thing as it gets cheaper. However, most of the time, people average down because they refuse to admit that they have made a mistake. They are too proud to be honest with themselves.

    I was once proud and Mr Market made me pay an expensive, painful price.

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  5. I would like to share my experience too as a newbie as I only started in stocks in 2009. Based on my experience with managed funds, in which I did before jumping to investing stocks myself, I think that averaging down is really a good strategy BUT you have to make sure certain things are sound such as the company will not go bankrupt within 10 years, its cashflow is still positive, it carries a well known brand etc.

    Another thing, you need to have a safety margin. Everybody defines safety margin differently so you need to find your own safety margin. One of the safety margin is that the stock is trading on very low PE compares to its PE average. Maybe another safety margin is that the market capitalization is above certain value of your own comfort.

    I also emphasize on diversification and build up your portfolio with different companies that have different economic forces. This is very important for newbie (myself included). This method has save me a lot. I have my own experience with stocks that declined slowly. It is killing me to see it bleed on daily basis in which it bled weeks with no turning point. If I had not force myself on diversification, I would have pumped in more money into that declining stock which would make me weep and give up. Once I have diversified enough, that stock already down 50%.

    That lead to another advice, as a newbie, have a very big spread before pumping more money. I'd say at 30% down. You need to have the discipline to keep your money in the bank as the saying goes a bird in hand is worth more than 2 birds in the bush.

    That stock that down more than 50%, it shot up 100% the next month in a 3 days period, too short a time for your reaction to buy more. That means you are breaking even. See, you never know what lies around the corner and you never will have a perfect information. And I believe no one else have. That same stock will drop tomorrow too, nobody knows for sure. Thus I think that you really need to have a confidence in your analysis.

    I hope it helps. As for me, I am still learning and reading everyday. Warren Buffet's annual shareholder letters can give you very good advice and confidence. You can visit it at www.berkshirehathaway.com . But, it is very important to have your own analysis and get confidence in yourself.

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    شركة تخزين اثاث
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