I’m not at all convinced that everyone could do this, and for many the Lifestyle aspects of being totally focused on the Markets all through the Day is not going to appeal or suit their Personality but for those with the right attributes it could work really well. For those of us who have a longer term Approach this Blog will still be a really useful read and there are ideas and concepts in here that are valid on whatever timeframe you use. And of course even if it doesn’t match your Style then as someone who is involved with the Markets in a committed way you will probably find it a very interesting read and it will expand your overall knowledge in a very positive way.
The Blogs come in 3 Parts and they are as follows:
- Part 1 - Mindset and Risks
- Part 2 - Traps and Biases
- Part 3 - Final Thoughts.
Lastly I just want to thank Michael again for writing this excellent set of Blogs and allowing me the honour of having it on my Website.
HOW TO TRADE WORTHLESS JUNK AND MAKE MONEY
PART I – The mindset of a winning trader
AIM is home to all sorts of guttersnipes and ne’erdowellers, crooked directors, and pumpers who’d ramp their Gran in if it meant they could sell for their 10%. It’s very easy to be suckered into a story about the next big thing because as humans we are predisposed to a great story, but unfortunately the story seldom turns out as expected. Therefore, one needs to exercise caution and be aware of their own weaknesses. If it’s excitement and the jackpot you crave, then head to the casino as it’s much cheaper.
Stock trading is no different to any other sport. It requires focus, effort, and a willingness to evaluate and improve. Those who have competed in sport at a high level will have an advantage though this is in no way necessary. There are many great traders in the market today, certainly ones who are much better than I, and having learned from many I sincerely believe anyone can do it if they are willing to learn. The information is out there and freely available for anyone wishing to do so, and there exists a vibrant Twitter community for UK stocks, with many people happy to help and share information and experiences. I can count myself lucky and be grateful to far too many people to name, for I was in a position to start trading and investing full time within a year of my first trades. Whilst a lot of this was down to my own desire to learn it would not have been possible without the existing community.
The following post is just some of the lessons I’ve learned on my journey, and I have highlighted in bold takeaway points and quotes from my favourite books and traders, which are listed in the final post of the article and available in Wheelie’s bookshop. I hope that some of you will find the following useful.
"Winners focus on winning and doing what works – if it’s not working, stop doing it" – Mark Minervini
Having the right mindset is imperative. "Oh, I could never invest or trade stocks". Imagine that! This one thought immediately excludes the thinker from all future wealth in the stock market. As humans, we only ever feel our thoughts, and if we can consciously monitor how we think we can control our actions. A mistake is either a crippling setback or an opportunity to learn. Should we fear our doubts or doubt our fears? In the stock market, it’s behaviour and results that count.
"The realization that you are responsible for your results is the key to successful trading. Winners know they are responsible for their results; losers think they are not" – Dr Van Tharp
There are very few industries where someone without the right education, without the right connections, and without the right capital can outperform someone who does. Trading is one of those industries where beliefs and mindsets will ultimately determine your results. A losing trader can very easily become a winning trader just by deciding to do things differently.
"And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!" – Jesse Livermore
Trading is an arms race – knowledge and speed of execution. You need to execute without haste when the opportunity exists, but it’s no good being quick if you don’t know what you’re reacting to. If you find something that works, it really doesn’t matter what it is as long as it is making you money. Conversely, if you keep losing money – stop doing it! Review your trades. Evaluate the process. Re-test. Repeat.
"A 25% loss needs a 33% return to breakeven. A 50% loss needs a 100% return to breakeven. Are you smarter than the market? I’m not" – Mark Minervini
Stock market clichés such as "cut your losses" are repeated because they are true – without a stake you can’t trade. It’s that simple. Unfortunately, many people new in trading start counting their profits before they are even earned, and end up becoming anchored to their wished for price. I was lucky in that I had the fortune to hear about other people’s colossal wipe-outs which terrified me, and as I had very little money to fritter away my initial profits and losses were small and I worked hard for them. By chance, I immediately avoided the knockout that sets beginning traders back or finishes their stock market endeavours completely with the loss of both capital and confidence. For example, a family friend lost untold amounts in the Dotcom bubble and concluded that all stocks are risky, and has missed out on nearly two decades of stock market value creation. This narrative is so powerful that my family still has a deep distrust of stocks. If you can continue after any initial losses, there is plenty of time to learn the craft and learn how to consistently churn out money from Mr Market. It’s easy to be a bit shaken and have confidence in your trading dented after riding the Carousel of Claptrap Trades but you must continue and keep cutting your losers.
"Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in" – Paul Tudor Jones
In my case, Mr Market was not content with being cheated, and allowed me to make a great deal of money very quickly, at which point he delighted in showing me I was no different to any other stock trader who begins to think they needn’t pay as much attention to risk. They were losses big enough for me to never want to be in that situation again. Cut your losses and you vastly improve your odds of success – I genuinely believe that if every trader managed their losses better their trading would improve volumes overnight.
"Fate does not always let you fix the tuition fee. She delivers the education wallop and presents her own bill, knowing you have to pay it, no matter what the amount may be" – Jesse Livermore
It’s much cheaper and more encouraging to learn from other people’s mistakes. Just remember, if you can’t temper your emotions and manage your risk Mr Market will be sure to keep you in line. We live in an unprecedented age where knowledge is no longer a privilege; it is easily accessible online and without cost. Paul Scott (@paulypilot) and Graham Neary’s (@GrahamNeary) Small Cap Value Report (published every day on Stockopedia) really helped me to develop my analytical skills and to broaden my knowledge of UK small cap stocks. It’s free. Websites such as WheelieDealer’s and various others are also free. @conkers3 has interviewed and published nearly 50 interviews with private investors. Tuition fees in the form of trading losses do not have to be high if you are willing to do the work before jumping in with your hard earned cash (and why would you not be? Losing money is no fun – trust me on that one).
Buying and selling in stocks is not a zero sum game. Unlike the bookmakers, the odds are stacked in your favour.
Many people believe the stock market is a zero sum game and that for every winner there is a loser. Time is infinite, and markets regularly make new all time highs, which shows that value and wealth are constantly being generated by the stock market. It is true that much of that value is created by the market leaders. Still, if you invested in a FTSE 100 tracker for a period of ten years between 1996-2016 there was a 95% chance you would have made money by being in the market according to a study done by AXA Self Investor. The average total ten year return was almost 70% - that doesn’t sound like a zero sum game!
But it depends on your playing field.
In the opposite end of the stock market from 1995 to 2015 over 72% of stocks listed on AIM declined in shareholder value (‘AIM – 20 years of a few winners and many losers‘, Financial Times, 2015). That suggests that for every one winner there are nearly three losers! In more than 30% of cases, shareholders lost more than 95% of their investment (ibid). If you ‘invest’ in AIM, you’d better be prepared to lose all your money, because it is not such an unlikely situation.
Despite what you are constantly led to believe, risk is not quantifiable. You cannot define it on a spreadsheet.
The problem with risk is that many have the wrong definition. It doesn’t come from statistics or numbers. It doesn’t come from low beta or high alpha. It comes from not knowing what you are doing. It comes from not understanding what you stand to lose and gain. The ‘risk’ of investing in AIM shares is higher, but so are the returns, and due to the inefficiency there are often trades which are heavily skewed with a risk/ reward ratio in your favour. In my opinion, larger market cap shares are riskier. They barely move and when something goes wrong they drop 30%. Can you read and understand Vodafone’s balance sheet? I can’t. I’ve got no idea what a convoluted controvertible constructible bond is and so I have no edge. When you’ve got ten brokerage firms all covering Boohoo with their own specific teams dissecting every part of the discounted cash flows it’s very difficult to compete. That’s not to say you shouldn’t ever buy these stocks, because as an investment Boohoo has been stunning, but trying to gauge any short term edge through fundamental analysis is pointless. It can be done in small caps, but just because a stock is listed at £5m and has £10m in cash doesn’t mean that everyone is suddenly going to buy it and close the value disconnect.
Play where the big boys and the ‘smart’ money don’t.
With many institutions not bothering to invest in stocks below a certain market cap, this creates a huge pricing disconnect which the knowledgeable can use to their advantage. A slightly negative RNS that may impact a stock price by a few % on a liquid market can easily wipe 30% from a company’s valuation as punters and hot money sell out. If you know the company, and you understand the reason for the drop, and if the catalyst still exists, you are in a position to make a judgement call on attempting to capture a quick move by buying the drop and selling into the rally. Small companies that issue excellent results can often see prolonged rises as institutions buy in and hoover up stock (see Hvivo HVO in recent weeks due to Neil Woodford buying).
If the market was efficient, then stocks trading at discounts to NAV wouldn’t exist. The Efficient Market Hypothesis assumes that every market participant knows all of the available information and prices it accordingly, but that is just not true for the AIM market. A handful of trades can move a price 20%, and so forced buyers and sellers can create disparities to take advantage of. The inefficient market provides opportunity. Even in stocks that are worth £100m, one private investor can shift the price with a few thousand pounds of buys or sells if the stock is held tight.
In an inefficient market – YOU are the edge.
Mr Market is the fairest employer of them all. He does not discriminate against race or religion, nor care about sex or for age. If you want to compete at a high level, that means putting in the effort needed to achieve that. I recall Paul Scott remarking at Mello that he couldn’t understand why people kept asking him how he found all of his stocks. The answer was and remains surprisingly simple: Get up at 7am and read the RNSs! Those who have a broad knowledge of the stocks in their chosen playing field are in a position to contextualise the RNS and react the quickest when material news is released. As well as reading the RNS announcements every morning, I use filters on SharePad to add to a watchlist of ca. 500 stock charts that I review on a nightly basis. This helps me to spot accumulation and bases in stocks and stalk entries on my favourite technical setups. Do the work. Show up. Compound this knowledge over time and your edge will develop.
One of the brilliant things about the AIM market is that every now and again the punter’s dream stock appears, the ‘ten bagger’ – a stock which appreciates in value ten times from its original point. These are, of course, rare, but they come along every now and again to keep punters playing the roulette wheel. For every one person who manages to catch one, there are many more who have lost money trying to do so. There is nothing wrong with punting money around if that’s what people want to do, but they provide the liquidity for people who do want to make money and have worked harder. If you have no edge, then quite simply you’re being used as liquidity for someone else who has one. I’ve yet to catch a ten bagger stock, but multibaggers are real and they are achievable for those who do their homework and time their entry right.
"And for a sucker play a man gets sucker pay; for the paymaster is on the job and never loses the pay envelope that is coming to you." – Jesse Livermore
When you are the edge, your goal is to take money from those who’ve not worked as hard as you. When you make the conscious decision to become a winning trader you will go through the motions required like a successful athlete who strives to stack the odds in their favour. Failure to prepare or to not treat risk with proper respect will eventually show up (or not show up in this case) in your pay packet.