www.InvestmentGuide.co.uk www.InvestmentGuide.co.ukShares A Beginners Guide to Making Money Contents
You can make a lot of money on the stock market, but it means some work, a basic plan and above all gaining experience. It can be fun too.
Most people have investments in the stock market through life policies, saving schemes, unit trusts, now usually called OEICs (open ended investment funds), investment bonds and perhaps a few hundred shares they were left. Many such investors don't have the time or the inclination to actively participate in the stock market but nevertheless wish to benefit from economic growth and protect themselves from the ravages of inflation. This Guide is not for them. Unless, of course, they wish to make a lot of money as quickly as possible.
This Guide is about speculating on the stock market. Does the word speculating frighten you? It should not, because there is an element of speculation in all investment. People talk about speculative shares but there are times when it is hard to justify even buying Government stock or a blue chip, a share in a large established company, on any grounds except speculation.
The speculator aims to outperform the investor by studying the market, developing a skill and hopefully finding the occasional big winner. It's not that easy. If you think that it is, or simply a matter of luck, then you could lose a lot of money. However when the winning shares are listed in the newspapers it makes you feel how easy it might have been. Some people are tempted by stories of shares bought for a few pence and sold for several pounds. They have little knowledge of how the market works, how to start trading in shares, or how to proceed once they hold them. When they get bitten and lose some of their hard-earned money they moan about bad luck and put their depleted capital back into the building society. Or, worse still, they become desperate and gamble wildly in an attempt to retrieve their losses.
Obviously, the speculator takes greater risks than the investor. You can be both an investor and a speculator. You would certainly be foolish to speculate all your money. But keep the two types of deals separate. Before you make a purchase decide whether you are making an investment or a speculation - and keep your objective firmly in mind
How much money should you speculate?
First put aside and keep sufficient for your basic needs and insurance. After that it is a personal decision. Never borrow to play the market.
Move slowly. In fact, it's a good idea to play the market for a while without using any money. Buy and sell some shares in an imaginary way while keeping your money in a high interest account.
Be serious about it. Keep records showing every purchase as though you had given the order to your stockbroker. Calculate the total cost of the purchase, including broker's commission. Don't fool yourself. Remember you must pay commission on a sale too.
Play the game until you feel confident, then tot up how you have done. If you show a good profit then consider playing for real. Also compare how your money would have done on deposit in a bank or similar institution.
Dip one toe in the market. Use only one third of your speculation fund and be prepared to lose some. Regard it as part of your tuition fee. As with many other aspects of life there is no substitute for real experience on the stock exchange. But naturally, you should aim to avoid paying too high a price for your experience.
Beware of beginner's luck. You may start in the middle of a raging bull market, a time when shares are generally rising in value (more about that later).
While there is no minimum amount needed to enter the stock market (fortunes have been made from an initial stake of £100 or $100) in practical terms these days £3,000 ($5,000) is probably the smallest sum required for each share.
How many different shares should you buy?
The long-term investor should certainly not put all his eggs in one basket but the speculator should play for meaningful stakes. After all, if you start with £30,000 and buy ten different holdings of £3,000 each spread evenly over the market you are unlikely to pick ten winners. The most likely result is that in a rising bull market you will make a small profit over, say, a three month period, and if a bear market, when shares generally fall in value, you will make a loss. In other words, the winners and losers will cancel each other out. Even if you make a profit the chances of you becoming rich in time to enjoy it are exceedingly rare.
Also, the more shares you hold the more time you must spend monitoring their movements and worrying about them. You can become confused, panicky even, and that could be fatal. You are like a juggler trying to keep too many balls in the air.
The stop-loss system
That is all very well, you may say, but if I buy only one or two different shares and they go down I stand to lose a lot of my stake. The answer is the stop-loss system.
This is how it works. When you buy a share you set a price at which you will sell if the price begins to fall instead of rising. For the average share the stop-loss price should be set between 10 per cent and 20 per cent below the price you paid. With actively traded shares in large companies such as Shell and HSBC, the stop-loss level can be reduced to between 5 and 10 per cent. A share in a smaller company in which dealings are less frequent, or a more speculative share in which the price movements are greater, would warrant a higher margin, say up to 30 per cent.
Note that in the current market (at the time of writing, second half of 2008) even actively traded shares have become very volatile (especially bank and retail shares) which means that price changes of 5% or 10% or more up and down in a day can occur. In the light of this you may have to use wider stop loss criteria otherwise you will become a very frequent trader.
As the share price rises so you increase your stop-loss figure. For example, you buy Shell at 400 and fix your stop-loss price at 360 (ie 10 per cent margin). Shell goes up to 450 so your stop-loss price becomes 405.
Sounds simple. If your stop-loss margin is 10 per cent then you cannot lose more than 10 per cent of your stake, plus your stockbroker's charges. But you have to maintain firm control. It's easy to be swayed by other opinions and considerations. The idea of limiting your loss on a bad venture is the most difficult for some speculators to accept.
It's not a perfect system either. No system is. Otherwise there would be many more rich people around. Not all shares which drop 10 or 20 per cent go on down. By using this system you may sometimes sell a good share too soon and frustratingly watch it go on up and up. That is the price you pay for operating a safety net.
Stockbrokers in the UK don't normally operate automatic stop-loss systems on behalf of their clients. The ordinary speculator must keep an eye on his own shares. Using one of the on-line dealing sites, you can usually obtain a price quote quickly or from your stockbroker by telephone. Fixing the stop-loss price is a test of your experience and skill.
One of the chief exponents of the stop-less system was Nicolas Darvas, a professional dancer, who made a fortune on Wall Street, where the New York Stock Exchange is based, without ever going there. He had his own personal technique. You will appreciate as you read on that speculating is a very personal business.
Checklist
1. Are you investing or speculating?
2. Set aside sufficient money for your needs before you decide how much to put in your speculation fund.
3. Never borrow to play the market.
4. First play the market without money.
5. Begin slowly and beware of beginner's luck.
6. Decide how many holdings to buy.
7. Practise the stop-loss system.
Last updated 19
January 2008.