I want to grow my knowledge on the Stock market to become a better investor. I wont mind sharing with serious thinkers anything that would improve their approach to the bourse. Here is an excerpt from a book worth reading. Which is the book?


Selecting the right share for investment is no different in principle to identifying the right company to purchase as a business investment or a property purchase as part of a property investment portfolio. An astute investor will treat share investing as a business. For the purposes of this chapter we assume that our investor has decided to purchase an imaginary share that trades on the Australian Market.

The first objective of our investor clients is to obtain some information about their potential investment. Investors are not always aware that a lot of factual information is published about a share, which can be accessed through many media outlets such as the newspaper, the Internet and many other sources. This information is generally free. Given the availability of such information, there maybe little benefit in spending say $10,000 on a software package if you are attempting to keep your concepts and strategies simple like Jamie.

On a daily basis, most major daily newspapers publish share market tables that provide a daily summary of trading of many stocks. These market share tables are prepared for the general public and contain a lot of useful information such as how a share has traded over the last 12 months and the last day. Other useful information includes the last sale price of a share, and whether or not the share has increased or decreased in value the previous day.

So let us look at the process of researching our imaginary share. The daily newspaper informs our investor how a share has traded in the last 12 months. Research on our imaginary share will identify that the share has traded to a high of say $26 and it has been down to a low of say $16. If an investor was unaware of this information and a recommendation was made to purchase this imaginary share at $19, on what basis would an investor make a decision to purchase?

Surprisingly, many clients have purchased shares by applying the guess or hot tip technique.
Astute investors understand that guessing about your financial future or taking someone’s hot tip is not a sound basis for making a business decision. Many of the world’s astute investors would never adopt the guess or hot tip philosophy. Our investor client has now identified that in the last 12 months our imaginary share has peaked at $26, bottomed at $16 and is currently trading at $19. Having done so, further research should be undertaken to identify what factual information has been published to assist in making a business decision.

Websites that provide free research information include but are not limited to www.asx.com.au www.comsec.com.au www.macquarie.com.au www.stanford.com.au The next objective is to determine at what price to buy the share and whether the share is good value.

To assist with this decision, there are two forms of analysis that are available to investors. One is called technical analysis and the other is fundamental analysis. While Jamie tends to use a little bit of both, his primary reason for succeeding at investing in the market comes from his ability to make and keep concepts very simple. Most of our clients now use one or more of the many expressions coined by Jamie to explain their investment objectives in a very simple and uncomplicated format. Simplicity in understanding and communicating a strategy has been advantageous to most clients. Many people make life difficult and complicated, therefore if something seems too simple, human reaction is to be negative to the concept. A mistake many people make is to believe that in order to be wealthy and successful, you must operate from within a complicated environment. An important ingredient that both Jamie and many other clients appreciate is that in order to implement an investment strategy you require focus and commitment, while simultaneously allowing the process to be simple and uncomplicated. Human nature is to complicate simple concepts and strategies.

Two things that an investor must understand that drive the market are the emotions of humanity — basically fear and greed. For the market to rise, the emotion of greed will in most cases drive the market up. The emotion that tends to drive the market down more rapidly is that of fear. We have all witnessed the panic and fear following September 11. Unless you follow the market closely you may not be aware that when common sense prevailed, the market picked up and regained lost ground. It is interesting to note that since World War II there have been around 26 crises that have caused the market to drop suddenly. On each of those occasions, the market has rebounded to a higher level than its previous high.

FORMS OF ANALYSIS

The first strategy that a potential investor may consider is commonly termed technical analysis. Here you examine patterns of share price changes, rates of share price changes and changes in the volume of shares traded in the hope of being able to predict and profit from future trends. Investors may also consider fundamental analysis. Here an investor can review such factors as sales, profits and assets of the business, which are “fundamental” to the company in question. It is always handy to know if the company in question is making a profit and is relatively large and stable. Some investor clients prefer to trade in large stable companies that usually make a profit, as they believe this strategy significantly reduces their risk.

Investors generally review the low and high prices for the previous twelve months to gain an indication of whether they are paying too much for a particular share or are purchasing the share for a much better value and price. Some investors believe that this form of analysis will eliminate some but not all of their investment risk. If necessary, the more careful investor can paper trade a share to build confidence. For those who are unaware of the concept of paper trading, this is a process in which you make investment decisions without committing real money. The investor will approach a paper trade just as they would a real trade, taking into account everything an investor would consider if they were making a real investment, and recording their investment decisions on paper. By looking at how a theoretical investment performs an investor can evaluate how well their investment approach is working, without the pressures of possible financial loss.

Once the confidence level is satisfied, a paper trader will become a live trader. In this transition from paper trading to live trading most of our clients have sought guidance from an authorised and licensed full service broker who can assist with the provision of advice associated with both technical and fundamental analysis for a particular share. CHANNELLING The second strategy for an investor client is a concept that Jamie coined “channelling”. For the technically minded, this strategy is referring to the price range of a share, that is, the range between the highest price and the lowest price reached by a share during any specific day, week or year.

By following the charts of many companies, one can visually identify that the price range of a share will move in patterns. For instance, our imaginary share traded as low as $16 before trading as high as $26 within a single price range cycle. In a subsequent price range cycle, our imaginary share ran back down to say $16, then returned to $19, then back down to $16, back up to $19. Investors begin to recognise that our imaginary share is following a pattern. In this example, our imaginary share is channelling sideways. In some instances shares will channel upwards and in other instances shares will channel downwards. Astute investors who follow the market become aware of those shares forming a pattern. Armed with this information, next time that share is around $16 an investor may consider purchasing the share having the benefit of understanding the price range over an historical period, be that a week, a month, a year or longer.

Assuming that the share price returns to $19, the investor must decide if the share is to be retained or sold. Common sense dictates that the share should be sold making the investor a potential profit of 20%. If this were the decision, the investor may instruct his brokers to repurchase the share when the share price is trading at the low end of its price range.
Assuming that our imaginary share has channelled up and down four times in a year, and assuming that the investor is making 20% profit every time the share is bought and sold, after the fourth time, the potential profit would equate to a profit of 80% per annum. Thus by adopting a channelling strategy, the investor can theoretically increase investment returns dramatically. The concept of channelling has been adopted by many investors who can identify those companies who channel up and down within a relatively consistent price range.

While the strategy of channelling is relatively simple and uncomplicated, many investors fail to follow the fundamentals of this concept. Investors fail to check the price movements of a share and to identify if the share price has moved up or down. Not adhering to the fundamentals often leads to investors purchasing a share at the top end of the price range, which in the case of our imaginary share is $26. Observing the financially educated client investing in an opposite manner to that of the unsophisticated investor is an education in itself. In its simplest format investing in the opposite manner is generally the process of selling a share at a price and accepting the profits of the trade. For example, when our imaginary share is trading at $19, the financially educated investor may elect to sell whereas the unsophisticated investor may hold onto the share. Doing the opposite to other investors may require the financially educated investor to make decisions that are contrary or opposite to the opinions of some financial advisors or professional share traders.

Greed may stop many investors from selling our imaginary share at $19 and fear would stop most investors from buying our imaginary share at $16. Remember, fear and greed may be your greatest enemies and that is why a large proportion of this book is devoted to developing the right mindset of the investor. While many clients simply wish to understand and immediately implement an investment strategy, in the early stages, it may be more advantageous to adopt, develop and work on a mindset. Astute investors understand that if the mindset is not addressed then emotions will interfere with common sense investment decisions.