If you would be wealthy, think of saving as well as getting.
—Ben Franklin (1706–1790)
Founding Father of the United States
Too Many Triggers—Too Many Failures
When technical analysts talk about investment tools, they tend to mean adding “just one more signal to my graphs, so that I can make even more profits.” In 2015, at the height of the housing madness, a new client came to me and asked me if I would review his strategy. He had 67 technical indicators, among them the following.
If you try to assess 67 triggers, where to start? There are so many that the share price becomes a straight line. Imagine adding yet another indicator to the preceding mess? When I rather too bluntly told him that he needs to use a maximum of six indicators to be successful in trading, he laughed.
“What fun is that?,” he was appalled that I would even suggest such a thing. What I was actually proposing was that he amend his strategy to become more efficient with less work. The strategy was simple: reduce the number of signals, but create a watch list to assess stocks that are triggered by the more relevant number of signals.
The Watch List
To continually profit from a changing market, you must be focused in conducting due diligence on the companies triggered by your technical signals; you need to do this before you buy the shares. The argument against conducting any form of analysis is common enough; by the time you have conducted your research, the share has already moved. The simple answer is that your research should be ongoing and not reactive.
Secondly, the share may have moved, but what if that move was against your expectations? It is all very well to say that research wastes the time you could be trading, but that research can save you from trading inaccuracies.
If you know your trading business well, you will admit that success is made up of more than just trading. You need to be ready to recognize and take advantage of prices when the market makes them available. The ability to do this accurately takes knowledge and skill, which are not derived from merely having a multitude of indicators. As experience has shown, the difference between making a living from trading and making serious cash is paying the right price for the securities.
The following is a sample of investment tools that will help you to become that efficient trader.
Avoid Mixing Your Trading Signals
Every month Johnny buys a 10-kg bag of dog food. He pays 25 dollars a bag, and the price has stayed unchanged for the past six months. As the months go by, Johnny believes the price of the 10-kg bag will rise—it has to, it simply must—and he begins to wonder whether he should buy two or maybe three 10-kg bags at the end of the next month.
At the end of the month, Johnny goes to the market, holding his breath. Has the price gone up? Why did he not buy more bags the previous month? He gets to the market and he cannot believe it that the price has actually dropped. What does he do now? Does he buy five or 10 bags? Does he buy the normal one bag and enjoy the saving? After all, dog food does have a long shelf life.
Surely, the sensible thing to do is buy more than one bag and take advantage of a lower price, which simply means that lower prices equal an advantage for consumers. In the stock market, traders act in horror at a drop in price, but for the long-term investor, a lower price must be seen as an advantage.
Stated differently, quality stocks have a long shelf life, and investors should buy them in order to use them in the future. Instead of seeing temporary low price as an opportunity to buy a security that could grow in the future, the trader sees the lower price as an indication to sell his or her own stock. Assuming a trader had a certain share in his or her portfolio, surely he or she must have believed that this specific share had a long-term potential.
A temporary market aberration should be an opportunity and not a disaster in the making.
Avoid Market Madness
When the market goes crazy, either bullish or bearish, I go away on a holiday.
There is a stock market contradiction that never fails to amuse. While it may be okay to be greedy, when traders get caught up in market madness—panicking when bears roar and greedily buying during bull runs—they are reprimanded by their stockbroker bosses.
There is no skill in buying or selling shares during strong bull or bear markets, but it takes unprecedented courage to go against mass hysteria and buy when others are selling. Across the world, traders repeatedly do the same thing; when markets climb, investors pour money in, and when markets fall, investors take money out.
There is no other clearer evidence of a less profitable strategy than a classic buy high and sell low! What is worse, this process is continually repeated. Traders simply cannot restrain themselves from continuously changing their portfolios. In fact, trader and investor behavior is often so weird that they throw away years of long-term strategy to ultimately achieve dismal results. Industrial psychologists around the world have tried to understand what makes them function. Strangely, no matter how much time or money it takes to draw up a long-term plan to meet an investor’s specific requirements, their perceptions and expectations are substantially influenced by their market experience of the last few months, and in some instances, the last few days.
As the head of research at a stockbroker, I was asked whether the company should dump its shares as the market was “too high to last!” I reiterated that a fall would be temporary, and that dumping the shares would result in massive losses over time. The portfolios would be disrupted and rebuilding them would cost more than the small benefit of selling before the fall.
I had hardly left the boardroom when the directors started to sell everything they held. The market did fall, but had recovered within three months, and as stated, they could not get the stocks at the lower prices.
Do not Listen to Doomsayers
Despite the availability and use of powerful technical systems, why do so many traders still lose? An answer is that traders are often too close to the market, and consequently, cannot be objective. A colleague once remarked, smiling, that broker X had jumped off the top of a cheap hotel in an extremely poor suburb of Johannesburg. This person was what I term an ultra-bear, which means that, no matter how well or bearish the market is doing, he believed the market would crash, crash, and crash again.
The broker had committed suicide, because he was not prepared to face losses he was rumored to have made. My colleague was, essentially, happy in his misery. The markets were crashing and he was right—it had only taken 18 months of hearing him constantly proclaim the coming of doom.
“The overall index is still higher than when you started your doomsday cries,” I said and walked away. As traders, both broker X and my colleague were concerned with daily statistics to the exclusion of monthly overall trends and had lost sight of the big picture.
When a trader changes a portfolio weekly, he or she is making the assumption that, during the next week, the markets will behave like the last week. In other words, the best parameters for a forecast period of time are unlikely to be the historic trend that has just occurred.
All traders, in all markets around the world, go through losing periods—no matter how brilliant their strategies may be or what type of approach they have chosen. Performance cannot improve by constantly changing the strategic approach to managing investment portfolios. As there are many more losing approaches than winning ones, traders actually decrease their chances of success by frequently changing systems.
The best advice I ever received from a successful stockbroker: “If you want to be a doorman, be one at the Hilton.” In other words, if I wanted to be successful as a trader, I should know what the investing public wants and buy before they do. Alternatively, if you want to be a global player, you have to be in the international arena. Remember that the same rules apply for all markets. If an investor can trade for an extended period in a wide variety of markets, he or she will likely be successful, although success in never guaranteed.
This works although markets change their short-term patterns; they tend to show similar long-term trends. That is your edge. If a trader plays the trends, he or she is likely to succeed in the long run. Attempting constantly to modify your system to mimic the changing patterns of the recent past will not improve your chances of success.
It will more likely ensure failure.
Measuring Liquidity
Traders often avoid looking at financial statements, because these seem too complex and a waste of time. A client told me that annual reports were for “those who consider themselves above common people.” In fact, financial reports provide you with information about the company, and also about its market and often about competitors.
Note that one of the trickiest problems for traders and investors is the ability to measure liquidity from a balance sheet, particularly when a company is approaching the market in a Rights Issue. This is the term used for a new issue of shares for funds. The importance of a new issue is its influence on share price.
A basic explanation, but logical, on the effect of share price is as follows:
• A company’s earnings per share is calculated by dividing attributable profits by the number of shares in issue. Consequently, if more shares are issued, the earnings per share must fall as a number.
• If you assume an unchanged price earnings ratio, then the share price will fall.
• Remember that share price is calculated by multiplying share earnings per share by price earnings.
The astute trader also knows that the injection of capital into a company’s balance sheet will influence liquidity. As such, a cash injection improves the company’s liquidity ratio and ability to expand operations. This, in turn, means that the lower calculated share price should be temporary.
It is common practice for a company to rule off its books when stocks are at their lowest, which obviously reduces the problem of stocktaking; it also means that the cash balance is at the year’s highest, and therefore, the balance sheet shows the greatest strength. When a trader is set out to evaluate a group’s liquidity, he or she must first establish the nature of the trade and the time in the trade cycle that the books are being ruled off. Then—and only then—can the effect of a capital injection be determined.
Cash Flow Per Share
This is the new bottom-line filter.
When all rubble has fallen around you, and you look at the remains of a company’s financial ruin, you want to be in a position that you can smile and walk away; unhurt, in a true trade’s sense. You can only do that if you are certain that every investment or trade that you make is based on an ultimate bottom-line safeguard.
That filter is the cash flow per share.
The logic is that a company without cash will ultimately fail as debts catch up and ruin financial strength and ratios. If, however, the company generates more cash per share than its share price, then you can be 90 percent certain that the company’s share price has a natural fundamental support level.
Definition: CFPS (cash flow per share) is a measure of financial performance that assesses the cash flow generated by a company and expressed per share.
The difference between CFPS and earnings per share (EPS) is that the latter looks at the attributable earnings of a company on a per share basis. The higher a company’s CFPS, the better it is considered to have performed over the period.
Skilled traders also use the same method to calculate sector CFPS and then use the information to draw comparisons to other companies or sectors. The following example shows a company with a 200 cents CFPS. When the line is drawn on a share price graph, you get an indicator of when the share is overpriced or not.
Essentially, all prices above the 200-cent mark suggests that the company is trading above fair price, while below the 200-cent mark, the company is undervalued.
Patience
Even when traders have carried out all fundamental and technical analysis and want to buy a security, they cannot control the market and related price actions. So, instead of waiting for the entry level to be triggered, traders often plunge in.
Patience is a scarce commodity in stockbroking, and particularly among traders. Here is a simple suggestion: have more than one security that you want to buy. That way, you are looking at multiple entry levels, which should keep you busy and avoid too early market entries.
As investors and traders have no control over markets, look at what you can control. This really boils down to you and your patience. A suggestion is to conduct research while you wait for a value price before making a purchase.
Chapter 11 takes technical analysis to new heights, with combining triggers to get greater accuracy.