----- Original Message -----
Sent: Wednesday, June 27, 2001 9:40
PM
Subject: [sharechat] LEARNING TO
INVEST>>>Disciplined Investment Decisions
Disciplined
Investment
Decisions
Don't let the human psyche
rule
By
Peter Maiden
June 2001
So
you have finally taken the plunge and got some shares in your favourite
companies!
Now comes the hard part. How does one
get the best overall return from the investments you have made.
One school of thought is that you
should hold the shares through both the good and bad times. The reason being
that over time a widely diversified portfolio of shares generally return, over
time, more than investments like government stock and bank deposits.
.
If you wish your investments to make
a return in line with the general performance of the sharemarket it is
probably a better idea to put your money in a managed fund. That way you are
letting professionals do your investing for you without all the hassles of
managing your own portfolio.
However, seeing you have put your
hard earned money into buying shares your intention is obviously to achieve a
better return than a managed fund. This does not mean you need to regularly
trade your shares each time the price rises or falls. Rather it is a matter of
timing the sale of shares to make the most of your investments.
Do you want to see good gains made
not being realised? Do you want to lose more than you need to by holding on to
losing shares?
The answer to both questions is
no.
However the human psyche makes us do
some some funny things.
Most
investors have a fear of making mistakes. Even deeper is the fear of actually
taking losses on some investments.
If the price of a share falls
from $1.00 to 80 cents some investors will hold the share - because they will
regret it more if they sell and the price goes back to $1.00 than if they hold
and the share price drops another 20 cents.
Conversely regret can also
motivate some investors to sell a winning share at $1.20 (instead of waiting
for it to increase further) for fear of it falling back to
$1.00
The fear of making mistakes
also leads to procrastination when it comes to selling losing stocks. Because
some investors fear making a loss, they sometimes hang on for years to these
losing stocks. Even worse is when this fear is combined with an emotional
attachment to the company involved.
A recent book 'You Only Make A
Profit When You Sell' by Charles Beelaerts and Kevin Forde mentioned studies
of shareholder's physchological behaviour which showed that some
investors also fear success, and will not sell to realise a gain. The authors'
answer to this was 'to overcome the fear of success, aim to treat success as
an imposter which will not last - then take full advantage of
it'
What's the answer? To get the
best overall returns why not adopt a stop-loss strategy. One that restricts
losses on losing shares - and locks in gains on winning shares.
For any share you purchase put a
floor price below which you will not own that share. You could set this
stop-loss at 15% below the purchase price. When the price falls below that
stop-loss level you sell the share.
The stop-loss is not the only trigger
to sell a share. You will usually sell for other reasons but use this
stop-loss strategy as a discipline to restrict losses and capture some
benefits on winning shares. That way you are not letting the human psyche
drive the decision making process.
For shares increasing in price you
should regularly raise the stop-loss level as a means of keeping some of the
profits. When a share price goes up 20% put a new stop-loss at 15% below
the new price - and so on at each 20% increase in the share
price.
These parameters are ideal for a
longer term investor...
This is how it works. Say last June
you bought some Sky City shares at $6.10. The original stop-loss would have
been $5.19. When the price went to $7.32 ( $6.10 + 20%) a new stop-loss on
this share would have been $6.22. When the price got to $8.78 ( $7.32 + 20%)
the new stop-loss would have been $7.46. The current stop-loss (based on
a price of $10.53) will be $8.95.
If the Sky City price drifts back to
$8.95 you should sell - you will retain $2.85 in profits. Hopefully the Sky
City share price will continue to rise. When it does and the price gets to
$12.63 you impose a new stop-loss level of
$10.75.
Using such
a strategy is a discipline. This strategy will restrict losses and allow most
of the gains you make to be locked away.
Above all
no investor should regret making the odd loss - I am sure that your losses
will be be out numbered by the gains you make.
It really
is a case of mind over matter. We all need to put some rules in place so the
human psyche does not win out in all cases
Good investing
(Publishing Note:
The LEARNING TO INVEST series is a concept developed by Gerry
Stolwyk. This post has been produced at his
invitation)
See IRG research reports
