Investing: Building Up An Equity Portfolio

It is not sensible to put all your money in one company. It is better to spread it over at least ten companies, which means having at least £10,000 to invest, as it is not economic to put less than, say, £1,000 in any one due to minimum dealing costs.

Consideration should also be given to share sectors. It is risky to have too much invested in one sector. Many newspaper City pages recommend individual shares to buy or sell but this can push the price up or down before you can react. Information is also available on the Internet.

Company reports can be obtained to provide more information.

There are also tip sheets, which recommend individual shares. They are expensive and one wonders whether the tipper keeps the best ideas to himself.

Word of mouth can be useful and it is a good idea to watch out for new ideas and successes, such as, for example, a shop which seems to be doing well or a product which you have bought or is recommended by a magazine or TV programme.

Smaller companies

There may be a narrow market in smaller companies' shares, which can make them difficult to buy and (particularly) to sell. Also, smaller companies are more likely to go bust than are larger ones.
However, good smaller companies can be valuable investments as they tend to be cheaper than larger companies, have higher dividend yields and provide a greater potential for capital growth and dividend increase.

Fundamental analysis

This term is used to describe choosing shares by looking at the fundamentals the financial results for recent years, including statistics such as profit and dividend trends, the annual and half yearly reports, recent announcements by the company, share price history, share dealings by directors. In addition, there are the statistics for the sector in which the company's shares sits.
Technical analysis
It is possible to carry out what is called technical analysis, which can be done on a computer using a proprietary system. Graphs of the price of each share can be drawn and you can superimpose on them the relative movement of an appropriate index, short a,nd/or long term averages and stop/loss points.
There is a lot to be said for using both types of analysis rather than only one of them.

International shares

It has become easier to invest directly in shares outside the UK, following the introduction of Jiway, which is a recognised investment exchange under the jurisdiction of the Financial Services Agency. The cost to brokers is set in euros at an amount of less than £5, so their charge to you should not be astronomic.

When to buy and sell

Theoretically you should buy shares when the market starts going up and sell when it turns down but few of us can distinguish a blip from a trend. In any case, individual shares may not move with the market.
There is a great tendency to sell a share, which has fallen in price, particularly if it goes below the purchase price, and to buy more of a share that has risen. This may be the right action but decisions should be based not on the past but on expectations of the future.
Cut losses, but let profits run. However, it can be sensible to sell part of your holding of shares that are showing a good profit, leaving in, say, the equivalent of your original investment, particularly if the shares are highly volatile.
Do not churn (continual dealing) as dealing costs can mount up.
Above all, do not panic when prices fall; take the long view most big market falls (sometimes called corrections) are followed by a fairly quick recovery and what seems a catastrophe at the time later becomes only a small blip on a trend line.

Defensive stocks

Shares in some companies are recognised as defensive, which means they are worth holding in periods of uncertainty.
Examples are:
stores - people need to live and therefore will buy clothing, food and drink;
utilities such as electricity, gas, oil and water - likewise there has to be a continuing demand;
transport such as bus/coach and rail (but perhaps not air) - demand for these will also hold up.

Value investing

This term describes the purchase of cheap, unpopular shares, as opposed to growth investing sectors expected to have considerable growth. Together, the two approaches are called style investing.
Suitable shares for value investing are considered to be those with high cashfiow, dividends and earnings yields, and high ratios of sales and book value to share price.
Over the very long run, value shares appear to outperform growth shares, possibly because of the greater volatility of the latter (the tortoise and hare phenomenon!)

Hedging

There are various ways of protecting your shares from an expected fall in the share price (or in the market as a whole) without actually selling them. They also have the advantage of locking in a profit but deferring a potential capital gain.
All use the techniques of 'going short' selling something you have not got, which can be very risky on its own, but because you do hold the shares the high risk is removed

The stock market

The Stock Market is one of the largest markets in the world, so it is going to be around for a long time. This means that if we can master a few strategies that bring consistent profits, it is not inconceivable that we could set ourselves up with a reliable income stream. The fact is, one of the most profitable skills we can ever master, is the skill of trading.
But trading the markets can also be very stressful. Many an optimistic graduate from some guru's course, has become disillusioned with the passage of time, as they watch their hard earned capital draining away to the point where further trading is no longer viable. Sometimes this even accompanies a career being neglected, as professional development gives way to an obsession with "finding a way" to make it work. Every spare minute is spent swamped in the markets. Newsletters, bulletin boards, forums, articles, books, courses, software, even tipping services - all become the new learning path.

Trading can be the fastest way to go broke. The market doesn't do the same things all the time. So one day a particular tactic will work, the next day it won't. Compare this with a normal everyday function like walking down the street. If you walk into a lamp post, you soon learn that you need to walk round them. But in the market-place, the lamp posts keeps moving as you approach them, you can never be sure that you can get round them. But what you can do is develop the mental discipline so that even when you do bump into them it's OK.
You have to learn trading skills, which ultimately are about 95% of this game. In the end, it's not about the markets - it's all about YOU. You are the essential element behind the way you trade.
Markets move from extreme to extreme across all time frames. They are a manifestation of human psychology, driven by fear and greed. Peaks are driven by greed, troughs by fear. This is obvious in the very long-term extremes. At the extremes the key point is that price is stretched unrealistically. Why is this? Because traders and / or investors are paying too much, selling too cheaply, because it is an emotional decision.

To win you must put yourself outside that emotion.
The big question here is whether you can develop the discipline if you do not have it naturally. I believe that the answer is "yes, you can," but you must have the necessary commitment to do so.
Clearly self discipline is going to be a requirement even to start the process. However, the market itself is going to be helpful, although not as helpful as it might be. Ultimately undisciplined behavior is going to be punished by the market, either by direct losses or by the loss of profits which would otherwise have been available. But the market does not help as much as it might because of the principle of random reinforcement. This is the market's tendency to reward bad behavior from time to time. What works one day may not work the next and this applies to the "best" trading practice. Similarly , bad habits do bring rewards from time to time.
This crucial fact is one of the reasons that it takes so long to learn how to trade. It is important then to discover techniques designed to develop and enhance your discipline and to recognise when you have let your discipline slip. You'll be amazed at how much easier your trading becomes when you master this.

MONEY MANAGEMENT

Money Management is what makes your analysis/system work, not the other way around. Money Management is far more important than analysis. It is not your entry which is that important - it is your exit. Your exit determines your overall risk, your overall profit and your overall control. Your entry cannot wipe you out - but the way you exit can. Your entry does not make you a profit - the way you exit can.

RISK MANAGMENT

The traders who win are those who minimize risk. This is another key lesson and cannot be overemphasised.Those who do not minimize risk inevitably pay the price and get wiped out.
Risk Control includes the following:- (1) Not trading in too big a size, thus reducing the risk of a wipe out. (2) Not holding overnight unless you have a profit buffer in place. (3) Not holding over the weekend, subject to the same as reason "2". (4) Taking appropriate action prior to major news items. This means not normally opening positions, maybe reducing position size if already positioned - although it does depend on your trading objectives.

DESIGNING A SYSTEM

First, you must define the aim of your system. What do you want it to do? Do you want it to catch trends? Do you want to trade ranges? How much risk do you want to incur? What success ratio are you looking for? Primarily you can look to trade ranges or you can look to trade trends. Trading ranges means looking for extremes and entering when such extremes are reached. Trading trends means looking to catch trends and entering once your system indicates that a trend is in place. You can also combine these two approaches.
In both cases you need to define your trading conditions. You need to define a range or a trend. Once you define what you are looking for, you simultaneously define how to catch it.
You can define trends in many different ways. First you have to decide over what time frame you wish to define the trend. You must then use that time frame to give your trending signal, for example if you feel that you want to day-trade trends then you must in some way define the trend using charts of a few minutes.

Once you have defined the trend you will have your trend indicator. So if you decide that a higher high on a 5-minute bar chart means that you have an uptrend then that is your indicator.
There are 7 fundamental components of a successful trading system and every one of them must be in place before you can hope to become profitable.

How Stock Exchanges Work

The Stock Exchange is a marketplace for buying and selling shares. There are two groups:

Stockbrokers, who buy and sell for you. They arrange the deal and receive commission, which might be 1 % with a minimum amount of perhaps £15.
Market makers, who buy from and sell to you. They get the difference between the buying and selling price the spread (this is usually about 1%).

There is a new trading system, called order driven trading (the old system is called quote driven trading), operating for high value companies SETS (Stock Exchange Electronic Trading System) whereby buyers and sellers are automatically matched. However, deals are still set up by stockbrokers.
Some large companies have set up means to trade in their shares at lower costs than are charged direct by stockbrokers.
In addition to commission, stamp duty of 0.5% is payable on purchases.
Adding these together and you have to achieve a gain of about 2.5% to break even.

The animals

The Stock Exchange is full of nicknames. You have already met stags but there are two more important animals bulls and bears. Bulls are optimistic and believe share prices will rise; bears take the opposite view.

To go with the meat there are chips! Blue chips are shares in big companies thought to be relatively sound, such as BP Amoco and Tesco. Then there are white chips smaller, sound companies.

Share prices

Prices of popular shares are printed in most daily and evening papers and can be found on Ceefax/Teletext and on the Internet.
They are usually grouped into sectors, such as stores, electrical, engineering. Lists of share prices will include some or all of the following:

Yesterday's closing price: this being the middle market price, halfway between the buying and selling prices.

• Yesterday's increase/decrease, shown as + or the previous day's price.
  
• Highest and lowest prices in the last 52 weeks.
  
• Market capitalisation total number of shares times current price, a measure of company size.
  
• Gross yield last full year's dividend before tax as a percentage of the current price.
  
• P/E ratio price divided by earnings (profit before tax) per share, i.e. how many years' earnings to recover the share price (theoretically the higher the figure the better the potential growth).
  

Share price indices

Most people have heard of the 'footsie'. It is the FT/SE (Financial Times/Stock Exchange) 100 index the 100 being the largest 100 companies by market capitalisation.
The other main index is the all share index comprising all the shares quoted on the main exchange. There is also the mid 250, being the next 250 after the top 100, and the recently introduced Techmark index for new technology stocks. There are also indices for the main categories of shares on the London market and for foreign shares Europe, the US, Japan, the Far East.

Settlement

Most transactions are now settled electronically through the Crest system, under which share ownership is registered in the name of a nominee.
The old system using transfer forms and share certificates is still available but may cost more.
Settlement of electronic deals is now made three working days after the transaction date. For certificated dealing it is still ten days.

Alternative investment market

In addition to the main market, there is also AIM, the alternative investment market which deals in shares of companies which are relatively new and small. It is an intermediate step before the main market.
Stock exchange regulations are less onerous than for the main market, but this does not in itself mean more risk for the investor.
Shares quoted on AIM are more volatile, may be difficult to buy and sell due to restricted numbers and are certainly more risky due to the newness and small size of the companies. However, large profits can be made.

OFEX Market

This is a market for trading in shares in unquoted companies, that is companies which are not quoted on the main or AIM markets and are therefore much more risky.

Stockbrokers

Some operate on an execution-only basis whereby they just deal in accordance with instructions. If advice is also needed, it will cost more. Deals are usually arranged by telephone or using the Internet.

Why Bonds May Be Better Than Stocks

Bonds may not be as visible in the media as stocks. There’s a lot more excitement that surrounds the area of stocks which makes them written about in the press a lot more. In fact, there are investors who have never heard of a bond even though they may have dabbled in the stock market and even looked at instruments like traded funds and futures. However, the fact remains that though bonds might not be as high profile and very often bring in lower returns, they are probably safer and healthier.

Stocks have a certain thrill that comes attached with them. Picture yourself buying a stock and waking up the next day to watching it having risen in value by 10%. It’s heady, that feeling. And of course, investors who watch their stocks doubling in a few months feel that they are very smart or they are very lucky! But inbuilt with the thrill factor is also the factor of risk. Stock prices are extremely volatile and what goes up, up, up can come crashing down in a moment, totally unexpectedly. Very often, the swings can be very large and rapid indeed.

Bonds on the other hand have a more boring tag attached to them. But if you look closely, they do come in a variety to choose from – reliable and unexciting U.S. or corporate AAA 10-year ones that give you a steady but small yield to junk bonds that can give you more than 15%! With bonds, too, you have to weigh them with the same principles as you would stocks – the calculated risk factor against the rewards you hope to get. This is the standard trade-off. However, the risks in the bond market are considerably lower and what’s even more comforting, they are easy to calculate.
You need more capital for the initial investment in bonds. You might only get one bond for a hundred shares of $10 stock. You’ll also find mutual funds that invest mainly in bonds and your broker could advise you about other options like ‘pay as you go’ plans. The trouble with bonds is the fact that you can’t trade them as easily as you would stocks. As far as stocks go, for most of us, it’s a matter of a few clicks of the mouse. Bonds however, require you to make that telephone call and not all bonds can be traded through brokers. Bonds also attract a higher commission. It’s best to check with your broker who will list out the options for you.
When you are looking at the short term, bonds are definitely less volatile. However, one thing they are sensitive to are interest rates. Bonds always have a coupon rate while shares have dividends which one could look at as interest being paid on the stocks though this could be sometimes skewed according to the whims of the management. Where bonds are concerned, the coupon rate is fixed at the time when they are issued. So if you are planning to sell your bonds, particularly before their date of maturity, this rate will be compared to other investments that give interest. So you will find that the prices of bonds are affected by not only what their coupon rate is but also how far they have to go before their maturity. Bonds tend to be more influenced by government policies than stocks are. What could affect bonds are massive borrowings, which could mean the government issuing bonds or by setting the prime rate lending rates or thanks to legislation that has an effect on insurance companies, banks or large institutions.

Therefore what seems to emerge is that it pays to have a diversified portfolio. Whether you directly buy them or you possess them thanks to your mutual funds, bonds spell a lot more safety and would be a welcome addition to your investments.