I hope you have enjoyed the festive period with your families and taken the time off to relax. Due to the pressures the stock market puts on us, and certainly if you’re an investor, it can add stress to our lives as global equities take a tumble.
That said, next year is another year. Another year to build on the lessons of 2018, improving our strategies and refining our stock selection processes. The beauty of compounding is that both money and knowledge compound and so every year we have a bigger advantage than the year before.
Extreme volatility often signifies a potential peak. We saw this in February, with the Dow plunging, only to recover and make new highs. However, there can be no doubt over the past few months that we are in rocky waters. The last week has been nothing short of a rout. I don’t believe that anybody can predict a recession (I’m certainly not clever enough to) and think that the only people who claim they can are either 1) lying, or 2) selling something - but managing risk is something that we can all do. We have had a brilliant bull market for the past decade – whilst nobody knows the top we can say with absolute certainty we are always one day closer to it. Headwinds such as interest rates and Brexit may not be resolved for a while, and though there is always something to be scared of, we are seeing significant changes in price action. Being prepared is the best defence.
If we think of the stock market as a football game, when the opposing team gets a man sent off, we want a fresh pair of legs on the pitch as a force multiplier against that weak point. Leverage. In the stock market, we take on extra risk when we have the advantage, but when we are under pressure we need to close ranks, and park the bus. Only by shutting positions down quickly if they go against us, and protecting what we have, will we be able to counter-attack effectively when the market turns.
I do not know what next year will bring, but we can assume volatility at least in the short term. I believe it is now wise (if you are not already doing so) to adopt a "risk first" mindset, where the first question is "how much can I lose"? This should already be the first question for any trader, but of course when Mr Market is generous we are happy to take on plenty of risk because we can expect outsized returns for doing so. Unfortunately, being long in a bull market is no longer enough to make money.
It’s no secret that capital is drying up in the City. A lot of placings are not being filled, and dragging into weeks before they even get them away. Crawshaw went bust – yes it was a terrible business, but there are a lot more companies on AIM that are worse. At least Crawshaw had revenue, and tangible assets. They actually did something (albeit very poorly) unlike many of these spurious companies which exist solely to make the directors rich at the expense of us shareholders. If you’re invested in a business that may need cash, I’d be very careful.
I think it’s likely that some stocks will halve. The problem with cheap is that it can always be cheaper, and if there are net sellers then the price is only going one way. If you can’t imagine how you would feel or act if this happened to you, then I think it is best to prepare a plan. The best time to act was yesterday. The next best time is now. The worst thing that can happen is reaching the puke point, when the pain of loss becomes too great to hold on. Of course, when that happens, the stock usually reverses which drives the dagger in deeper. Avoiding the puke point should be a priority, because pain of loss not only costs us money but clouds our objective judgement. I’ve been there before, and I never want to be puking again. I believe it’s a possibility that in six months we will see bargain basement in many stocks, but if we’ve blown our accounts before then we won’t be able to capitalise on that opportunity. Respect risk, and the profits will look after themselves.
At the end of the year, I like to print out all of my trades and go through them with a fine tooth comb, looking for errors and silly mistakes that I’ve made. Last year, I found that boredom trading was a real issue for me, and I have been a lot stricter this year. I am happy to say that "punting a share because I am bored" was not something that I did, and it has saved me a lot of money this year as I’ve consistently had a large cash position, dashing back to cash once the trade has failed or completed. Looking through your own trades will allow you to see what really happened. If you invested in a stock, are those reasons for investing still the same? If you’re a trader, did you plan your trade and then trade your plan? Why did you buy? Why did you sell? How did you feel when placing the trade – were you under FOMO (Fear of Missing Out) or calm and collected? By quantifying and crunching the data we can learn a lot from not only our trading but ourselves. Trading is not about scoring home run multibaggers (though I do enjoy those) but about eliminating mistakes and removing errors. This year, I found several new consistent themes that blighted my performance:
Not running winners
For investors, this is a common problem, but for a trader I am not so sure. There were some stocks that I owned that had I held onto them, I would’ve done a lot better. When Bushvield Minerals popped up on my volume filter when Atlas cleared, I sold this for 30% having bought around 9p. I thought this was a good trade as the risk/reward was striking and it was a quick move. Bushveld continued and even hit 50p this year. I must’ve bought it around five times after that for a trade, and made money on it every time, but had I held from 9p I would’ve done much better in this stock.
However, running winners can go both ways, because winning trades can often suffer from long periods of inactivity. I owned many stocks that went on to do fantastically well this year, but I also owned many that after I had banked them for 20-30% they struggled to achieve anything. For a trader who is trying to achieve high returns on capital, opportunity cost is a big threat. Recycling 20% winners five times in a row is a lot easier to achieve than hitting one 100% winner – yet it is the one 100% winner that can potentially do 200%, 300%, and really drive the tail end on the bell curve.
Clearly, I could solve this problem if I knew which stocks would keep going and which would not. The only way to know for sure and to not continuously be eating hindsight sandwiches for lunch would be to just run my winners. Banking some profit on the way up (there is only one thing worse than being 20% up only for the stock to reverse to your entry point and that is for the stock to go through your entry point) derisks the trade, settles that itch to bank, and will hopefully keep me in the trade for longer going forward.
I am generally disciplined when it comes to my trading. Cutting losses isn’t an issue for me, because I don’t care about being right. I just want to make money, and holding onto losing trades will only have me polishing off my CV and going back to work. However, there were some periods of time where I slacked off the charts for a night, only to see that I should’ve sold a stock on the bell the next day or I missed out on a stock that had broken out. No trade can ever break me, because I position size small, but this was needless money lost because I didn’t put the work in. I spent the majority of 2018 travelling, which was fun, but in future I need to be more disciplined regardless of circumstance. Staying up late and sleeping in cost me money.
Too many positions
As I said above, I like to trade small position sizes. This has resulted in me never having large drawdowns this year, but it also meant that at some points it became difficult to keep on top of every position. This does relate to discipline but having too many positions is not good for the psyche and it becomes a lot more time consuming to plan and evaluate what I should be doing in plausible situations. In some instances I actually forgot I had the trade on – sometimes this went well and sometimes it didn’t – but one thing is for certain I should not be forgetting! Next year, I will be trading fewer positions. This will help me as in a poor market it will force me to evaluate the strength of the position and fewer positions will mean better preparation.
Not scaling up when the situation presents itself
There were several times in 2018 when I thought that the risk/ reward was great and that I should’ve scaled the position size up. Rules are rules, but it is clear that there are some times where the rules need to be broken in order to outperform. Doing this and risking more would’ve given my annual performance a nice boost. It’s easy to say in hindsight, though.
Not shorting enough
I much prefer going long, as not only does shorting go against our inherent long bias but shorting small and micro caps can be extremely dangerous. It can also be difficult because sometimes a friend or people who I like are long of the stock, and taking the other side of the trade would mean having a vested interest in them losing money. This is not nice – and I know the trading arena is no place for emotions – but I like to see people do well for themselves and would not wish for anyone to lose money. It then becomes a conflict when opening a position where I would directly profit from someone who I like losing money. This is something that I am going to have to get over next year, because we all make our own decisions in the stock market, and we all need to take full responsibility whatever the result. Own your winners, but own your losers too.
Fixing your trading
The only way to trade successfully is to trade, evaluate, learn, and trade again. I spoke to several private investors who messaged me, and whilst I never gave advice on any stock, I did notice that a lot of the time these people were holding onto losing stocks that were not profitable and not generating cash, at a loss of 50% or more. This was a consistent theme, and it is loss aversion. Just as our inbuilt nature makes us hold onto losers, so our ego wants to be right and we cut our winners too early! I doubt very few people holding onto 50%+ losers have a reasonable or logical plan, or an exit point. This ultimately ends up in bigger drawdowns, more emotional pain, and fear of trading other stocks. If you’re a trader, those losers need to be cut. Or they’ll cut you so deep you won’t come back.
Another problem is that many people want to think that they’re long term investors, but they act like short term traders. A long term investor stays with the position for years and doesn’t bank for 20% in two weeks. A trader cuts their losses; they do not hold onto a losing position because they are scared to sell it. Don’t be the one who makes a short term trade only for it to become a long term investment in a piece of junk. We’ve all done it, but fool me once, shame on you. Fool me twice, shame on me!
I don’t think it is difficult to make money in the stock market. We all know how. But it is difficult to do the things we know that work. I am not a great trader. I still make silly mistakes, and do stupid things, mainly because I’m an idiot. But if intelligence was necessary then there would be a lot more traders. It doesn’t matter how clever you are – in the end it comes down to discipline and taking a long hard objective look at yourself in the mirror. If you can do that, you stand a very good chance of doing well in 2019. I wish you all the best.
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