Start With A Financial Plan
Trading stocks should be treated as a business venture - it will require time, knowledge and money to succeed. Your Financial Plan represents your roadmap to success.Decide Your Financial Objectives.
If you are a 60 year old looking for cash flow to fund your impending retirement, your priority would be to generate an income stream rather than large asset value growth.
If you are a 25 year old who wants to begin to invest, capital growth would be the priority, rather than income stream.
Your financial objectives will determine whether you trade liquid shares or not.
Decide Your Risk Level.
Decide on your risk level and the types of investments you can afford to make will be set. Remember, the higher the return you want to achieve, the higher the risk.
Low Risk Level
I am not very comfortable with risk and will invest in fixed interest/capital guaranteed securities (government bonds, bank term deposits).
Medium Risk Level
I can take on a moderate amount of risk (blue chip Industrial and Banking and Finance sector shares).
High Risk Level
I am comfortable with risk. I am seeking a high return and prepared to evaluate companies early in their growth phase (recently listed resource companies).
How Do You Fund Your Investments?
For most of us, we do not have immediate access to a large pool of ready savings. Using the equity you have in a property to fund your share portfolio is a common approach.
EPF savings is also an effective vehicle for providing funds for investing and the majority of Malaysians have access to these funds.
Most major banks and insurance groups offer margin loan facilities. This is where you start a portfolio with savings and then use this portfolio as security to borrow further funds to buy more shares.
In most instances, the problem is not acquiring funds to start a portfolio, it is having the knowledge to invest with confidence.
Employ Risk Management Strategies
With any investment, be it stock trading, real estate or business, it is important that you understand what the risks are and how to minimise your exposure to these risks. This process is known as 'Risk Management'.The Three Elements Of Risk Management
1. Spread Your Risk: Don’t Put All Your Eggs In One BasketSpreading you risk is as simple as not putting all your eggs in the one basket. This is called diversifying your portfolio.
Spread your capital so there is never more than 20% in a single stock.
Don’t however take this to extremes and over-diversify by investing in too many stocks at once. You cannot expect to outperform the market if your portfolio closely matches the market. A rule of thumb is to limit your portfolio to between 5 and 10stocks.
2. Plan Your Exit: What Is An Acceptable Risk?
Amateur traders buy a stock and their focus is to hope it increases in price. If it goes down, they continue to hold in the hope the price will recover. When a professional buys a stock they recognise that success is a probability, not a certainty. At the time of entering the trade they establish an Early Exit price. If the stock falls past this point the good investor will immediately exit and never run the risk of making a large loss.
Maintaining your capital is fundamental to successful trading. If you invest in a stock and make a large loss, then it is impossible to consistently profit from the stock market. Having incurred a large loss, you must now make a large profit just to break even. The key to successful trading is keeping your losses small.
3. Stop The Loss: Don’t Drive Without A Seatbelt
The second must sell signal is a Stop Loss. Just tracks the highest price reached by the share since purchase. If the share falls by more than 10% from this price, it is time to sell. We suggest 10% - you can change this depending on your trading style. Too small a percentage and it will get you out too early. Make the percentage too large and you give back too much of your profits before exiting. Start with a 10% fall and see what you feel comfortable with.
Always Trade With The Trend
Trends are the cornerstone of trading. If a share price is rising, we can make money by buying that share. If the share price is falling, we need to look for other opportunities. It does not make sense to buy a falling share. Our aim is always simple – find a share in an uptrend and take a large chunk from the middle of the trend.Overall Market Strength
It is important to look at how the overall market is doing. This can be gauged by looking at the top 500 shares, otherwise known as All Ordinaries. If All Ordinaries go up, it is because stocks in the top 500 have risen and the market is in an uptrend.
There are over 1000 companies listed on the Bursa Malaysia that you can invest in. To examine each one individually would take a great deal of time. Instead, you trade with the trend and find the strong sectors in the market.
Strength of an Industry Sector
What is a Sector?
A sector is a group of companies involved in the same industry. For example, mining companies are grouped together in the Materials sector while banking companies are in the Finance sector. Entire sectors are generally affected by economic conditions so entire sectors tend to trend in the same directions. Trends do not have hard and fast rules, individual stocks within these sectors will perform at different levels.
Strength of Shares in a Sector
Although the general rule of novice investors is to buy on an uptrend, there are people who buy during a downtrend as a strategy. This is a process of buying more shares as the price falls, so the average cost of the share is reduced with every purchase. This kind of bargain hunting is a riskier strategy, as the stock price may never recover. The second downside is that the price may fall and then stabilize, meaning the investor may have to wait for a while before recovering losses or making a profit. In this scenario, capital that could be used for profitable trading would be lying idle.
Resistance to this type of trading is not new. One of the greatest traders of the last century, Jesse Livermore wrote, “Experience has proven to me that the real money made in speculating has been commitments in a stock showing a profit right from the start.”
By now you should understand that trading with the trend is critical to success. Also, our objective is never to buy at the bottom or sell at the top of a trend. We simply want to take a large chunk out of the middle. Let the trend be your friend.
Don’t Buy And Hold
The Malaysian stock market is one of the strongest and sometimes most dynamic markets in the world.While the market has always recovered from falls, the same cannot be said for individual companies. Even during a booming market, some companies can suffer significant losses.
Trade only on an uptrend and sell the poor performers, this will make it impossible to experience a large loss. This is the secret to outperforming the market and achieving a consistently superior return.
Undertake some research on the Bursa Malaysia or in a local investment paper. List three shares that have showed decreased performance recently and three shares that have showed increased performance recently.
Trade Only Liquid Stocks
Look at the column called Lots Done in your market report. This is the amount of stocks that were traded on the day. If you multiply this by the price of the stock, you can see how much money actually changed hands on that day. If this amount is high, then the stock is very liquid, meaning it is easy to buy and more importantly, easy to sell. The last thing you want once you've bought a stock is to be stuck with it because you can't find a buyer.For example, if a company has traded 100,000 stocks today and the closing price was RM2.42, we can estimate that RM242,000 worth of that stock changed hands today.
For example:
Innovics' last price was RM 0.30 and Lots Done were 1000. This means that an average of RM 3,000 worth of stock changed hands today. In other words, Innovics is only trading an average of RM3,000 of shares each day.
Now, you own RM10,000 worth of Innovonics and you want to sell. If you enter your sell order on the market, you will inject 3 days worth of turnover onto the market. There will not be enough buyers for you to immediately sell the stock at your chosen exit price.
To ensure you invest in liquid shares, only trade stocks that show a daily turnover of at least ten times what you are planning to invest. If you are investing RM10,000 in a stock, look for an average daily turnover minimum of RM 100,000.
Develop Your Own Trading Plan
Trading is about probabilities, not certainties. A Trading Plan establishes a series of steps that ensure a higher probability of success.The Plan will set certain guidelines for:
What stocks to buy
When to buy
When to sell
The Structure of Your Trading Plan
A Strong Market:Before deciding what to buy, first establish if the market is in a positive phase. If the KL Composite Market has been negative over recent weeks (or longer), it is not a good time to enter the market. If the majority of stocks are going down or sideways, the probability of you buying a share that is going to rise in the immediate future is slim.
A Strong Sector:
Having waited until the market is in a growth phase, determine if there are any sectors showing strong growth in the past few weeks. These are the sectors that have stocks performing well and are increasing in price.
Examine stocks in these strong sectors and determine those that are on an uptrend, meaning the price of the stock has been steadily going up for at least 3 months.
These stocks will qualify as having potential for ongoing growth as they are generating positive market sentiment. If they have adequate liquidity on top of that, you could add any of these to your portfolio knowing that you could exit quickly at any point in time.
Exit Strategy:
Having selected shares to include in your portfolio you must then have an Exit Strategy in the event that these shares show signs of reversing. Simply set an Early Exit price to ensure that the stocks you buy never generate losses.
This is a simple description of a Trading Plan. It holds the basics for selecting stocks that have a good probability of increasing in price and risk management to protect your capital. These three ingredients are the key to success in stock trading.
