Picking bottoms is a dirty habit

There are many rules to investing and trading but one of the simplest and most important ones is simply that you have to mitigate risk and maximise return. In fact, it’s the bedrock of making money and without it, you are totally lost. I also spent months analysing data from scores, no hundreds, of investor portfolios and what I found didn’t surprise me. They all showed the same pattern – the real and ‘easiest’ way to make money is to focus on risk not on profit. If you get that equation right then your results will improve instantly. With that in mind let me share with you one tip to help reduce your risk overnight and that is this – you should never, I repeat never, ever, ever buy shares as they fall in value. It’s the one mistake that investors make over and over again. A share price falls and the temptation is to jump in and buy but you have to ask yourself the question why is the price falling? What do other investors see that you don’t? Are they selling their shares because they have made a tidy profit and they are now taking some of that profit off the table (known as ‘top slicing’) or even selling their whole position (which is a known as a full exit). Or is it perhaps because there is something fundamentally wrong with the company that they have picked up that you are not aware of? The reason that it’s difficult not to be tempted by cheap shares is the same reason it’s difficult not to be tempted to buy cheap ‘anything’. If you go the supermarket and you see a 2 for 1 offer on a product that you probably won’t use right away or certainly didn’t go out to buy, the chances are that you might be tempted to buy it anyway. That’s human greed right there. The difference is that when it comes to the supermarket you might end up spending five pounds and so no big deal, but when it comes to investing you could end up spending and potentially losing thousands, tens of thousands even depending on how a big an investor you are. And that’s the key. If you can eliminate those bad decisions when you make impulsive buys you will find that your overall performance should improve pretty dramatically. So how do I trade and what can you do differently? Well I have a little formula which I will share with you and it goes something like this. If a share price has fallen by more than 25% then the first thing that you should know is that this almost certainly it’s not ‘profit-taking’. Unless the stock has been on some mammoth run in terms of increasing share price, then a 25% fall can only mean that the shares are struggling and that the sellers are not profit-takers but people who are either shorting or sellers closing out their long-term positions. Either way there is trouble ahead. In other word, don’t buy! The second tip I will share with you is to get comfortable giving back. Don’t feel the need to get the very lowest price on the share. In fact, getting the lowest price on anything is not a good idea. I come from an Asian background, specifically my family are from Panjab in India. The fact that I was born in Coventry makes little difference to my genetic makeup and DNA – I like a bargain! I grew up poor, my parents grew up in poverty and my grandparents grew up in abject poverty where they literally could barely feed themselves. Given that background it’s hard not to listen to the lessons of generations to save money and get a good deal. But I have had to break that lesson and it’s not been easy. You see in life, at least in the Western World, it’s no about getting the best price. In India it is. Everyone is out hustling and every rupee counts. In the UK however you have to exchange on value, not price. It’s the same with trading and investing. Price is not the key factor and that’s why most investors lose (or at least are not as successful as they should be). The fact is that sometimes the worst thing can be actually getting the best price. That’s because you then begin to believe that you have acquired some mystical gift to pick tops and bottoms. Trust me you haven’t. I have been trading for 25years and I still can’t pick tops or bottoms. If you did pick a top or bottom it was because of sheer luck and you shouldn’t try it again. The way to give back in the market is to purposely choose NOT to buy at the lowest price. As counter intuitive as that may sound I hate it when I buy at the lowest price. It means that I got lucky, it had nothing to do with my ‘silky skills’ as I like to think of them. It’s like throwing a dart blind-folded and hitting a triple twenty. It might make you feel good but you’re not going to be stupid enough to think that you will pull it off for a second or third time. The problem is that for most investors they don’t realise that they are blind-folded. In today’s short video I give a quick example of RBS shares when they collapsed in price down to around 8p back in 2008/9. Buying at 8p would have been a terrible trade (even if you made the most money) because the risk that you would have assumed could have cost you 100% of your capital. On the flip side, investors who bought at say 12p or 15p would have had a much better trade because their return to risk trade off was more favourable. For the sake of losing say 10 pence (even if that represented 10/12 which is about 80%), it’s a better trade because this 10p is what I like to call my ‘insurance premium’. What I mean by this is that I am prepared to pay some of the price away to reduce my risk – similar to how you pay for car insurance to protect you from the financial risk of having an accident. For those of you who still remember the old maths classes of ‘distribution curves’ the equivalent is to never invest in the tails. You want to focus on the momentum of the trade and not the pivot points. The money is in centre of the move, the middle of the bell and the torso of the body. Not sure if my metaphors are helping or hindering but watch my video and hopefully it’s a little clearer.