By Ron Nathan
ORIGINALLY, when I wrote this article 6 years ago, it was entitled the Ten Commandments. However, this time, there are only nine, as I decided to omit the one about adultery. When Moses went up Mount Cyanide, he came down with two heavy tablets made of stone, engraved in Hebrew. Unfortunately, I am much older than he was, so I took the cable car up Mount Mayon and instead of bringing down two large tablets, I brought down two capsules. I had them translated from Mayonaise to English and here they are.
Despite the humorous introduction, the rest of this article will completely change your investment psychology and you will be a far better investor in the future. What follows is based on 59 year’s experience in London and Manila. You can profit from my observations and mistakes. It will be particularly useful for beginners whose knowledge of investing is limited. Good luck, and if you find it useful, cut out the articles and paste them on your bedroom or office wall, in between your pin-ups of Beyonce and Jessica Alba.
Commandment No. 1: Do Not Trade Against The Trend
You will be shocked to learn that almost 90% of investors in the Philippines, U.S., UK and Japan lose money in the stock market. This is because they ignore the first commandments and jump in only after the market has already had a big rise. Let us examine the Phisix first.
On January 9, 1997, the index stood at 3,420. Since then, it has been changed many times, with the worst performers weeded out and replaced by better companies. Despite this, the Phisix is still below the level it was 13 years ago. So, in theory, you have lost about 20 percent of your money but this does not take into account inflation, which in earlier years was very high. Adjusting for the depreciation of the peso, you have lost 40 percent. During this period, you would have received hardly any dividends whereas you could have earned 10 percent plus on bonds before. Allowing for the loss of 13 years interest, your real loss is around 60 percent.
It was the same story in Japan, where the NIKKEI plunged from, almost 40,000 down to 8,000, and is still only a fraction what it was in 1990. It would have been far better to have bought gold, property or an oil tanker. The value of super tankers had tripled.
So why invest in the stock market at all? The short and honest answer is that you should not, unless you follow the rules, which I will set out in the next few pages. The prime requirement is patience. There is no such thing as long-term investment. Ask the Japanese, whom after 20 years are still losing much of their capital.
You only BUY when the market has fallen and the technical indicators say that it is about to turn up. There are many indicators and I will deal with some in due course. Conversely, you SELL when that index has had a big rise and the indicators show that momentum is slowing down or is about to decline.
Players do not use their head, they trade on their emotions, and this is nearly always wrong. I will tell you where to get the necessary fundamental and technical data, but in the meantime, you can use a 20-day moving average of the index or any stock, which you hold. If you have a computer program, you have a big advantage over the average investor.
Commandment No. 2: Cut Your Losses Quickly
Years ago, before the 9/11 attack, a financial journalist wrote two books called Market Wizards, in which he interviewed about 50 fund managers who had outstanding records over a five-to-10-years period. Obviously, this could not be just attributed to luck so he interviewed them in great detail, hoping to find the connecting link. They traded commodities, currencies, options, futures and stocks.
They came in all shapes and sizes, short, tall, fat, thin, and it took him a long time to find theconnection. Some were pure fundamental analysts who never looked at charts; others were technical analysts who did not know one side of a balance sheet from the other. Some studied economics and neural networks while others preferred tarot cards or feng shui. Some had master’s degrees or doctorates while others came from the street where they ran the jueteng or sold drugs. Some were extremely serious and studied DESCARTES while others made terrible puns, were covered in tattoos and wore nose rings. It took him a long time before he hit on the solution. As the first four groups were highly leveraged, about 10 to 1, they followed the principles of POP COLA.
Prolong Our Profits, Cut Our Losses Aggressively
Incredible as it may seem, although they took great care in their entry points, 63 percent of their transactions resulted in small losses. About 30 percent made small gains while the remaining seven percent scored huge gains, doubling, tripling, quadrupling or even becoming 10-baggers, because of the leverage.
So, when you get it right, let your profits run until momentum stops rising. But when you get it wrong put a stop loss below your buying price, dependent upon your risk tolerance. Sometimes, this will be a mistake but it protects you against disaster. After all, you don’t complain about paying fire insurance because your house didn’t burn down. You can afford to cut small losses. It is the big ones that ruin you.
Commandment No. 3: Do Not Average Down
Under normal circumstances, I am against the death penalty, but not for those who break this commandment. They should be barbecued slowly over a fire while concentrated hydrochloric acid is dropped upon them. All the people I know who went bankrupt averaged down.
One client bought 20 million shares at 54 centavos on the advice of his neighbor who was a director of the company. I was acutely unhappy because the shares had risen from their par value of 1 centavo. Not only would he not sell at 50 centavos as I suggested, but also he averaged down at 40 cents, 30 cents, 20 cents and 10 cents. He had to sell his house and his business to raise the money. Finally, the shares stabilized at 1 centavo, before going bankrupt.
If you follow the second commandment, such disasters cannot happen to you. so you will never be faced with the decision of whether to average down.
Commandment No. 4: Do Not Overtrade
If you are trading every day, the only person making money is your broker. The expense involved is too high. You have to pay two commissions and a 0.5 percent sales tax. In addition, there is the difference between the bid and offer price, usually about 1 to 2 per cent. So you have to make four per cent just to break even. This is fine, so long as you BUY just as the stock is turning up, but if you deal constantly, the expense will ultimately cripple you.
That small percentage is enough to make all the incredibly costly casinos in Las Vegas profitable. They can afford to give free rooms, free food and drink, and free shows to high rollers because they know that a percentage advantage of 3.6% is enough to guarantee the house a sure profit over the long run. Trade only when the technical indicators tell you to. For the remainder of the time, do nothing. Patience is a virtue.
Commandment No. 5: Do Not Trade On Tips
In England, we say, “Where there’s a tip, there’s a tap.”
I am sure you all remember BW. The shares were run up deliberately by a consortium that, by tips and cross trading, created enormous volume and sent the shares from P0.40 (under a different name) to P108. Almost everyone except me got sucked in, mostly at the higher levels, and those speculators, who did not use stop losses, saw their shares go all the way down to P0.40 and below. One old lady wrote to me that her broker had recommended it at P104. Would she ever see her money back? I replied, somewhat unkindly, “Only if you believe in reincarnation.” These days, fewer people follow tips.
Commandment No. 6: Do Not Chase Prices
If the price runs away from you, don’t chase it. Most of the time, it will correct.
Commandment No. 7: Be Wary Of Inactive Stocks
The documentary stamp, which made trading in shares well below their par value prohibitive, has been removed. As a result, trading has increased greatly and numerically third-liners comfortably exceed leaders.
I have a computer program that tells me when a stock increases in price by a certain percent and its volume is 50 percent above its 50-day moving average. This alerts me to inactive stocks that suddenly become active. Often, the spread between bid and offer is too great or the number of shares available is too small to be of any interest but occasionally, it throws up something interesting.
Commandment No. 8: Buy Low Priced Stocks
By this, I don’t mean stocks quoted at a fraction of a centavo. I mean decent stocks standing around at P1 to P5. Obviously, it is easier to double your money on a low-priced stock than on a high-priced bank or insurance company. TEL, my most successful recommendation at P226 and now over P2600, is not likely to double from this level.
The Last Commandment, No. 9: LEARN TECHNICAL ANALYSIS and I will tell you where to get information.
If you desire to become a really competent investor, you must also learn global economics and fundamental analysis. By global, I do not mean that you have to study every country, but you must at least know what is happening in the United States. Wherever the American stock market is heading, the rest of the world will follow. After the 9/11 attack, the US market got battered for a few months and every other stock market followed the downtrend. When the US market finally got back on its feet, every other market recovered.
How do you learn about the American stock market? First, listen every night to Bloomberg, assuming that you have cable TV, and tune into CNN. Listen to Chairman BERNANKE when he addresses the Senate or Congress. If you cannot do this, then read his speeches in the newspaper or go to the Internet and check on CNN Money.com or Bloomberg.com and also read the commentaries. When Wall Street sneezes, the rest of the world catches pneumonia.
Basic Knowledge
For the local market, the business section should give you all the necessary information. But if you want more details, to the web sites of the National Economic and Development Authority or the Philippine Stock Exchange and listen to channels which are largely devoted to the economic and political situation of the Philippines. You can also enroll in courses at universities and colleges.
Next, you should have a basic knowledge in fundamental analysis. This means that you need to know all about companies. You must know how to read a balance sheet, calculate the earnings per share and from this, the price/earnings ratio. You need to understand what a yield means, how many times a dividend is covered, and what preferred and convertible stocks are. You should know book value and understand such concepts as debt and cash flows.
You can take a course in accounting or business management, and there are plenty of books, local and imported, in all the major bookstores. Or you can subscribe to my newsletter, which contains all of the above.
If you want to buy a simple but excellent technical analysis book, try TECHNICAL ANALYSIS OF THE FUTURES MARKET by John Murphy, available at local bookstores but expensive. It was written years ago but is still considered to be a classic. Every aspect is explained simply and it can be used for trading stocks, commodities, currencies or futures. Also buy Beyond Candlesticks by Steve Nison, a must. There are many sites on the Internet, which will teach you technical analysis and provide the necessary charts and parameters.
Good Luck!
